High Tech Play?

Richard Croft
May 1, 2011
6 minutes read

Waterloo, Ontario-based Research In Motion Ltd. (TSX: RIM, Friday’s close: $46.09) released its tablet computer a couple of weeks ago. But the “PlayBook,” as it’s called, met with less than enthusiastic reviews, and produced no line-ups at the local Best Buy store. Many of the big wireless carriers, including elephants Verizon Wireless, AT&T Inc., and Sprint Nextel Corp. are still sitting on the fence about whether to carry the gizmo, or at least are dragging their heels about putting the thing on display in their stores.

RIM is positioning the PlayBook as a business tool, rather than a consumer toy, like Apple’s iPad. That strategy makes sense, because RIM is in no position to compete head to head with the Apple juggernaut.

Apple Inc. (NASDAQ: AAPL, US $350.13) is going from strength to strength. First out the door with its market-busting iPad tablet, last week, it reported a 95% increase in quarterly earnings on an 83% increase in revenue. That’s a lot of iPads, iPods, and iPhones. It can’t keep up with the demand for the new iPad 2 iteration of its tablet. So far, it’s shipped 19.44 million of the iPads alone. Now, it’s poised to mint some more money by offering its popular iPhone in white. Go figure!

It is a story that RIM wishes it could tell. The real story, of course, is very different… RIM is losing market share. And not just to Apple, but more importantly, to Google’s Android. Evidence can be found in the worrying falloff in sales of RIM’s high-end smartphones. Suffice it to say RIM’s earnings outlook isn’t as robust as it once was.

Basically, RIM is between a rock and a hard place. A dud-on-arrival tablet and sharply declining sales in its high-end phone segment can’t be good news. And often there is no escape, especially in the merciless high-tech world.

In an effort to gloss over the most recent earnings downgrade, RIM talked up its new products which are expected to come to the market in the next month. But the market isn’t buying it! RIM’s share price fell 14.38% on Friday. Worse still, its shares are down 32% since mid-February. And many on the street think there is more to come. Analysts at National Bank have given up on RIM and have it as a sell, while RBC Dominion has effectively admitted they were wrong and in the process, dramatically cut RIM’s target price.

The problem when trading technology stocks, is that they have a tendency to surprise; both positively and negatively! And in the wake of those surprises, investors can get caught on the wrong side of a trade with devastating consequences. Especially if you are on the short side of a trade.

If you are looking for more downside in RIM, then use a strategy where there is limited risk. Put buying comes to mind. If you purchase a put option you can participate in further downside moves should they occur, but do so with limited risk.

The challenge with options is cost. Option traders recognize the frequency of surprises, and price that into the premium. For example, RIM options are trading at 45% implied volatility, which in terms of cost, means that RIM options are in the top quartile of Canadian options. In dollars and cents, RIM June 46 puts are trading at $2.75 per share.

Still the cost of options is only one consideration. The actually volatility (i.e. historic volatility) of RIM over the recent past is 60%, which if you believe that will continue, would make RIM options relatively cheap. Of course in the real world, option traders are simply betting that RIM will experience less volatility in the future then has been apparent in the past.

From a strategy perspective, RIM does not seem to have a catalyst that would trigger an upside surprise. Which means the path of least resistance is to the downside, and given the relative cost of RIM options, makes the RIM June 46 put a reasonable trade to exploit that point of view.

The other approach, if you are not convinced of the relative cost argument, is to look at a bear call spread. This is a credit spread where you are selling a close-to-the-money call and buying an out-of-the-money call to limit your risk.

If you prefer the credit spread strategy, consider selling the RIM May 46 calls at $1.85, while simultaneously buying the RIM May 52 calls at $0.35. This bear call spread generates a credit of $1.50 per share. If RIM is below $46 by the May expiration (three weeks from now), you will
retain the $1.50 per share net credit.

The maximum risk is $4.50 per share, which is the difference in the strike prices ($52 less $46 = $6 per share) less the $1.50 per share net credit.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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