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Analysts Tend to Follow the Market

Analysts Tend to Follow the Market

It can seem that analysts are positioned to warn investors of declines before they occur but that is not always the case. As Benzinga reported, Arista Networks Inc (NYSE: ANET) shares were plunging to a two year low after the maker of data center switches issued a downbeat fourth-quarter outlook recently.

ANET daily chart

Benzinga then reviewed analyst opinions on the stock:

“MKM Partners analyst Michael Genovese maintained a Neutral rating on Arista and lowered the fair value estimate from $275 to $210.

Wells Fargo Securities analyst Aaron Rakers maintained a Market Perform rating and lowered the price target from $270 to $205.

Citigroup analyst Jim Suva maintained a Buy rating and reduced the price target from $315 to $225.

KeyBanc Capital Markets analyst Alex Kurtz downgraded Arista from Overweight to Sector Weight.

MKM: Facebook’s Delayed Server Refresh Behind Arista’s Woes

Arista’s third-quarter results were solid, but the “scary” Halloween guidance was due to Facebook, Inc. (NASDAQ: FB), Genovese said in a Friday note.

The company did not name the specific Cloud Titan customer that is responsible for the fourth-quarter softness, the analyst said.

Arista noted a sudden slowdown in orders from Facebook at the end of the third quarter, along with large fourth quarter and 2020 forecast reductions, he said.

This, according to the company, is due to Facebook delaying its server refresh by a year, the analyst said.

The lower fourth-quarter sales guidance isn’t likely due to Facebook’s decision to switch to just-in-time procurement, Genovese said.

Despite the revenue estimates and the stock being aggressively reset, MKM is staying on the sidelines, Cloud outlook is significantly worse and there are meaningful deferred revenue headwinds in 2020, the analyst said.

Wells Fargo: An Evaporated Momentum Story

Along with the one-year pushout in server refresh at a major cloud titan customer, the 400G cycle is also being pushed out by 12 months due to a slipping optics ramp, Rakers said in a Thursday note.

The company’s guidance for flat-to-down year-over-year growth at its Cloud Titan customers in 2020 raises doubts regarding growth at the reminder of its customers, the analyst said.

Wells Fargo significantly reduced its estimates for Arista and views the company as an evaporated momentum story.

Citi: Investors Will Likely Take Wait-And-See Approach

The initial sharp downward move for the stock is warranted, given expectations for a 20-30% drop in sales and EPS, Suva said in a Friday note.

“Investors will likely take a wait and see approach for a few quarters as the year 2019 has now erased the stock gains and low visibility provides minimal confidence for a near term recovery,” the analyst said.

Citi’s financial model for Arista has moved materially lower, resulting in a significant cut to the price target.

KeyBanc: Reduced Visibility On Top Accounts Limits Conviction

Arista’s visibility within the Cloud Titan vertical appears challenged for a period of time extending well beyond the fourth quarter, Kurtz said in a Thursday note.

The analyst continues to see Arista as well-positioned competitively in the cloud vertical.

Yet the lack of near-term visibility with top accounts that started in early 2019 continues to limit the conviction in quarterly execution, he said.

KeyBanc now estimates Cloud Titan revenues be down $20 million in 2019 from FY18 and down another $175 million in fiscal year 2020.

Olivetree: This Could Take a While to Resolve

Arista’s pullback could hurt networking stocks such as Cisco Systems, Inc. (NASDAQ: CSCO), Juniper Networks, Inc. (NYSE: JNPR) and Ciena Corporation (NYSE: CIEN), component companies and server stocks, said Olivetree strategist Dan Forman.

Investors could consider rotating into hybrid themes stock and/or storage, he said.

With the company not guiding for fiscal year 2020, save for a commentary about tough comps, Forman said.

“This could take a while.”

Analyst caution confirms the chart pattern which shows a down trend.

ANET weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in ANET

For ANET, we could sell a November 15 $185 call for about $5.90 and buy a November 15 $190 call for about $3.80. This trade generates a credit of $2.10, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $210. The credit received when the trade is opened, $210 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade in ANET is about $290. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($210).

This trade in ANET, offers a potential return of about 72% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if ANET is below $185 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $290 for this trade in ANET.