Looking at Cree (CREE) Options Strategies Post-Downgrade

Citing valuation, Garp Research & Securities downgraded its rating on Cree (NASDAQ: CREE) on Tuesday to “neutral” from “buy.” The firm noted that shares of the LED lighting company currently trade at 22 times Garp’s fiscal 2012 earnings-per-share estimate and are therefore unlikely to move much higher from here.  The firm also said it sees “more downside risk than potential positive surprises.” CREE shares closed at $69.70 on Monday and this downgrade didn’t deter it from continuing to press higher in Tuesday’s session; the stock was up 1.1% at $70.44 in mid-afternoon trading.

While research and brokerage firms are largely limited to “buy,” “hold/neutral,” and “sell” designations, the playing field for options traders is far broader. Option traders aren’t limited by direction (whether or not the underlying stock will move higher or lower); they can trade based on perceptions of volatility, and whether the stock is likely to move sharply or trade within a range.

A virtual trading account from OptionsHouse can help you visualize the strategies you build before you try them out in the real market.

Whether you are bullish or bearish on CREE, there could be a potential options strategy that works with your risk/reward profile. Below are just two examples of ways options investors could trade CREE. These are not buy-sell-hold recommendations – just a pair of potential strategies in the bullish and bearish camps.

Bullish Option Strategy:  Broken-Wing Call Butterfly

Investors who disagree with Garp’s cautious outlook and think CREE has more upside left in it could consider buying a call butterfly. This trade could be executed Tuesday afternoon by buying the September 55/80 call spread for $14.00 (buying the 55 call, selling the 80 call) and simultaneously selling the September 80/85 call spread for $1.30 (selling the 80 call, buying the 85 call). The four-legged trade, consisting of a long 55 call, two short 80 calls, and one long 85 call, can be purchased for an overall debit of $12.70.

The maximum the call butterfly buyer can make is $12.30, which occurs if CREE closes right at the 80 strike when these options expire on September 17^th. If CREE is trading above the 85 level, profit is capped at $7.30 per spread.  Below 55, losses are limited to 100% of the debit paid ($12.70 per butterfly). This strategy will make money if CREE is trading at $67.70 or above at September expiration.

Bearish Option Strategy:  Bear Put Spread

Those who think the analysts at Garp make some sense could consider buying a bear put spread. Tuesday afternoon, the June 80/70 put spread can be purchased for $6.00 apiece (buying the 80-strike put and selling the 70-strike put). The maximum loss is limited to the debit paid, or $6.00, while the maximum potential gain is $4.00 per spread, for a return on risk of 66%. The trader will book the maximum profit at expiration if CREE shares are trading below 70, and will not suffer the maximum loss unless CREE moves above the 80 strike.  The trade will be profitable at any point below the breakeven level of $74.00 (which is about 5% above current levels).  So this strategy doesn’t necessarily require the shares to drop, it just needs them to not rally.

Can CREE shed a little light into your portfolio, on either the bullish or bearish side?  Let us know which strategy looks good to you … or if you have some clever ideas of your own.

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