Option Trade 
Cisco Systems, Inc. (NASDAQ:CSCO) Puts 
Tuesday, 09 February, 2016

**OPTION TRADE: Buy the CSCO Apr 2016 23.000 put (CSCO160415P00023000) at approximately $1.35. Place a pre-determined sell at $2.70.

Note: No protective stop losses added -- but if you wish to do so make it $1.10.

by Ian Harvey

February 09, 2016

Cisco Systems, Inc. (NASDAQ: CSCO), a network and communication provider, is set to report its fiscal-second-quarter results after the market closes tomorrow, Wednesday, February 10th. The networking company expects weak revenue growth during the second quarter, driven by economic uncertainty and currency issues.

Expectations are low going into Cisco's report, and the stock has slumped nearly 20% over the past three months. Cisco's guidance for the second quarter is light, with the company expecting year-over-year revenue growth of just 0% to 2%, compared with the low- to mid-single-digit growth the company has been reporting in recent quarters. Cisco blamed macroeconomic uncertainty for the guidance, an excuse that countless technology companies have used to justify cautious outlooks.

Following Cisco's first-quarter report, some analysts suggested that Cisco's problems run deeper than economic uncertainty. Ryan Hutchinson of Guggenheim Securities believes that Cisco's weak enterprise outlook is due in part to uncertainty around future network architectures. As an increasing number of organizations move to the cloud, Cisco will need to adapt to maintain its dominant market share.

Another analyst, Rajesh Ghai of Macquarie, is concerned that network function virtualization, or NFV, will put pressure on Cisco's networking hardware business by causing price deflation.

Goldman Sachs removed the stock from its "America's Conviction Buy" list, saying it expects macro headwinds to create potential challenges this year. Goldman Sachs also lowered its price target on Cisco Systems, Inc. by $3 to $32, while Stifel and Jefferies cut their price targets.

And, Kulbinder Garcha of Credit Suisse has maintained an Underperform rating on the company, with a price target of $22.

Garcha mentioned that “near-term IT data points remain mixed largely due to less visibility around service provider spending and global macro.”

Although revenues are expected to remain subdued sector-wide, F3Q16 guidance would benefit from the extra week. Garcha expects the company to generate revenues of $12 billion in F3Q, representing normal seasonality of 2.2 percent quarter on quarter.

Also, there appear to be signs of weak IT spending from “large bellwethers” and resellers of Cisco Systems, which suggests that the revenue expectations for FY16 could have downside.

“Despite potential near-term momentum, we remain concerned regarding the impact of SDN threatening what remains the most profitable part of the IT stack,” Garcha said.

The analyst explained that this would introduce competition at various points in the network and although the impact would take time to become obvious, the threat in terms of shrinking gross profit dollars was very real.

In addition, persisting margin pressures and long term project Oms of 26 percent could lead to low EPS growth, despite continuing share buybacks.

Also, the company's competitive position is continuing to deteriorate. While on the surface it may seem like Cisco is doing well, there is a belief that there are serious issues under the surface.

Basically Cisco's pricing power is being eroded and it requires ever more assets to grow or maintain sales levels. This is related to competitive pressures in the company's core network equipment franchise rather than any management or operational issues.

Some of the threat to Cisco is large tech companies like Facebook (NASDAQ:FB), Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), and Google/Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), which have increasingly turned to designing their own hardware and buying it directly from low-cost Asian manufacturers.

No matter how you look at things, the move into the cloud is likely going to continue to have a profound effect on both the demand for Cisco's hardware, and more importantly, its pricing power.

As well, various networking companies have sprung up to package white label hardware and open source software into solutions that can be sold to companies that aren't in the "behemoth" category like Facebook or Amazon.

Additionally, network engineers are starting to rethink the way networks are built and managed. Previously, networking hardware and software were integrated in the same device, and each piece of network hardware was updated or changed individually. Enter Software Defined Networking, or SDN. There seems to be no universally agreed upon definition of what SDN specifically is, but at a high level, it is the removal of the management level of the network from each individual piece of hardware and to a centralized software suite. The threat to Cisco is that a large piece of its value add and justification for price premiums will be removed. With SDN cheaper, generic hardware will be able to be more readily substituted. Indeed, we've already seen Cisco's gross margin fall from 66% to 60%.

Harvey’s Options Volatility Indicator

Therefore, based on the facts above, and Harvey’s Options Volatility Indicator, the following option trade is recommended…..

**OPTION TRADE: Buy the CSCO Apr 2016 23.000 put (CSCO160415P00023000) at approximately $1.35. Place a pre-determined sell at $2.70.

Note: No protective stop losses added -- but if you wish to do so make it $1.10.

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