50% Target Gain for This Straddle on Cognizant Technology Solutions

Technology companies have seen their stocks jump sharply since the market bottomed in March. A number of members of the sector have reported earnings in the last few weeks and quite a few more will report in the next few weeks. One tech company set to report earnings is Cognizant Technology Solutions (CTSH) and it is scheduled to do so on July 29, after the closing bell.

Like so many of the other tech companies, Cognizant has rallied sharply since March. The stock has gained over 50% from the low. The rally has put the stock in overbought territory based on the weekly stochastic readings and the stock is hitting the upper rail of a downwardly-sloped trend channel at this time.

The overbought status is somewhat of a concern as is the potential resistance. However, with a strong earnings report we could see the stock breakout above the resistance. Of course a poor or disappointing report could just as easily send the stock tumbling.

If you look at the chart for Cognizant, the huge move lower in April 2019 was the result of an earnings report. Conversely the big move higher in February of this year was the result of a positive earnings surprise.

Because I believe the stock could move sharply in either direction, I think the best way to play Cognizant’s earnings report is with a straddle. This strategy involves buying the puts and the calls at the same strike price. What you are looking for out of this strategy is a big move in one direction or the other — you really don’t care which way the move is, as long as it is a big move.

For Cognizant, the September 62.50 strike seems to be the best fit for the straddle. The red line on the chart represents the $62.50 level. At this time the September 62.50 strike calls are priced at $2.90 and the puts are priced at $4.00. This means that collectively the straddle will cost us $6.90 or $690 because the contracts represent 100 shares.

I have a target gain of 50% for this straddle and that means the combination of the put and the call will need to be worth $10.35. If you look at the green lines on the chart, those lines represent the price the stock will need to reach for the calls to be worth $10.35 or for the puts to be worth $10.35.

If the stock jumps up to $70, the puts probably won’t be worth anything or they will be worth very little. If the stock drops to $55, the calls will be worth very little if anything. That’s why the green lines are drawn $10.35 above and below the strike price.

Cognizant fundamentals and sentiment

Looking at the fundamental indicators for Cognizant, the company has performed relatively well in the last few years. It has seen earnings grow by 5% per year over the last three years while revenue has grown by 7% per year. In the first quarter earnings were up 5% and revenue was up 3%.

The company’s management efficiency measurements are above average with a return on equity of 20% and a profit margin of 17.9%.

One thing that really surprised me and something that could cause the stock to breakout above resistance is the sentiment toward the stock. The overall sentiment is skewed to the bearish side with only nine out of 30 analysts rating the stock as a “buy.” There are 14 “hold” ratings and seven “sell” ratings. Should the company issue strong earnings, we could see analysts upgrade the stock and that could help push it higher.

Yet another sentiment indicator that is higher than the average stock is the short interest ratio. The current ratio for Cognizant is at 4.0. Not only is that higher than the average stock, but has also increased significantly since March and that indicates increasing pessimism.

One way or another, I look for Cognizant to make a big move after its earnings report.