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Cisco Straddle Has the Right Ingredients

We have the perfect recipe for a long volatility trade.
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At first glance, there may not appear to be much going on with Cisco Systems CSCO. The stock has been in a slumber since the disappointing May earnings results, but is finally showing some life today.

When you pan back your view from a daily picture to a weekly one, there's an interesting pattern emerging that runs contrary to the potential breakout on the daily chart. Note, below, that since Cisco suffered the big drop in May, price has made a series of higher highs and lower lows to form a megaphone pattern. So while we have a potentially bullish development on the daily chart, my concern is with the weekly picture.

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Megaphone patterns are bearish in nature. The dilemma deepens with the bullish action in the Full Stochastics and StochasticsRSI along with the stock trading above the 13-week and 20-week simple moving averages (SMAs). This appears to be more than indecision. This appears to be a potentially major pivot in the stock to either break out or break down, with targets of $33.50 and $30, possibly as low as $29.15.

Fortunately, the implied volatility of the Oct. 20 options are trading with an intrinsic volatility of 13 while the stock has a 30-day historical volatility closer to 22. When combining a potentially volatile technical setup with low-priced options (IV well under HV), we have the perfect recipe for a long volatility trade via a straddle or strangle.

The stock is trading around $32.43 as I write this up, but once I factor in the $0.29 dividend set for Oct. 4, the adjusted price sets the $32 strike as the best suited strike for a straddle trade.

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The trade:

-- Buy to open 1 CSCO Oct. 20 $32 straddle at $1.18

Net cost: $118

Max risk: $118

Max reward: Unlimited

Days until expiration: 35

Breakeven: $30.82/$33.18

Risk: Moderately Aggressive

I would seek to take profits if the stock hit $30 or $33.50 and not consider a stop for at least two weeks as we wait for the pattern to resolve to the upside or back down to lower lows.

At the time of publication, Collins had no positions in any securities mentioned.