Thursday, January 31, 2008

Cadence (CDNS) - Decision making in the face of uncertainty

Today was one of those days that I hate. Everything is up and by a lot. As an options trader who makes money from selling time premium, this isn't my thing. Sure, I make money since I am generally positive delta and negative vega. (I will probably explain all the option greeks sometime -- mostly to help myself gather my thoughts learn them better. I mostly only use delta and I am trying to learn to use vega.) However, I write options expecting them to expire. So a market rally just helps to speed up that process a little bit. However, I ran out of margin a while back during the big dip and thus do not have many open positions for March. If the market is up, then it is hard for me to find a good risk/reward balance in options to write since I am mostly selling puts naked. So the ideal market is one that is perfectly flat (historical volatility of zero) while having a high implied volatility. That's what I dream about. Of course, the markets aren't so nice.

So I was looking for options to sell and noticed that CDNS (Cadence Design Systems) was down 33% to 10 a share. Cadence makes CAD (computer aided design) software for the electronics industry (some people call it EDA -- Electronic Design Automation). CDNS is to semiconductors as ADSK (Autodesk) is to buildings. Brought up a maximum length chart on Yahoo finance and saw:

CDNS is basically back to 1996 levels. Always a good sign. I like things that are at long term lows (that's my style of investing most days).

Took a look at the AP bulletin which was pretty useless. I am convinced that they are written by robots (or people playing robots). It calls CDNS a "semiconductor manufacturing equipment maker". Never a good sign.

Basically 4Q '07 was ok but guidance for 2008 is bad. 1Q is going to be a loss and full year guidance is down to non-GAAP EPS of $1.11 to $1.19 (GAAP EPS tends to be lower since EDA companies take write-offs for their acquisitions). The current Street consensus estimate $1.53 a share. With earnings potentially down over 28%, the price drop seems reasonable, right?

I disagree. I think the bad new was already mostly priced in. I am more than happy to go long this company at P/E of 10 (after lowered guidance, even better!). I sold a bunch of Mar 10 puts at 0.85 which would give me a basis of 9.15 if assigned. Otherwise, I get about an 8% return on maximum risk or a 50% return on initial margin (for 50 or so days).

I also feel good about the fact that 53 million traded out of 268 million outstanding. Combine that kind of volume with the flat intraday price action, it smells of major buying. There was a floor around 10 all day and a volume spike and the end of the day. We might see an SEC filing some time soon.

We'll see what happens. It could prove really dumb to try to catch this falling knife. Sometimes, there is no time for analysis, and it's mostly gambling with an estimate of the odds.

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