A Bullish Chart Pattern Indicates a 78% Gain is Possible In This Stock
Trade summary: A bull call spread in Power Integrations, Inc. (Nasdaq: POWI) using the December $60 call option which can be bought for about $4.80 and the December $65 call could be sold for about $2. This trade would cost $2.80 to open, or $280 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $280. The maximum gain is $2.20 per contract. That is a potential gain of about 78% based on the amount risked in the trade.
Now, let’s look at the details.
Power Integrations, Inc. designs, develops, manufactures, and markets analog and mixed-signal integrated circuits (ICs), and other electronic components and circuitry used in high-voltage power conversion worldwide.
The company offers a range of alternating current (AC) to direct current (DC) power conversion products that address power supply ranging from less than 1 watt of output to approximately 500 watts of output for mobile-device chargers, consumer appliances, utility meters, LCD monitors, main and standby power supplies for desktop computers and TVs, LED lighting, and other consumer and industrial applications, as well as LED lighting.
It also provides high-voltage diodes; and high-voltage gate-driver products under the SCALE and SCALE-2 product-family names. In addition, the company offers motor-driver ICs for use in refrigerator compressors, ceiling fans, and air purifiers, as well as pumps, fans, and blowers used in consumer appliances, such as dishwashers and laundry machines.
It serves communications, computer, consumer, and industrial markets. The company sells its products to original equipment manufacturers and merchant power supply manufacturers through sales personnel, as well as a network of independent sales representatives and distributors.
Business Wire carried details on earnings. “Net income for the third quarter was $14.8 million or $0.24 per diluted share compared to $0.22 per diluted share in the prior quarter and $0.29 per diluted share in the third quarter of 2019. (Per-share measures for all periods have been adjusted for the 2:1 stock split effected as a stock dividend in August 2020.)
Cash flow from operations for the third quarter was $16.2 million.
In addition to its GAAP results, the company provided certain non-GAAP measures that exclude stock-based compensation, amortization of acquisition-related intangible assets and the tax effects of these items.
Non-GAAP net income for the third quarter of 2020 was $24.2 million or $0.40 per diluted share compared with $0.33 per diluted share in the prior quarter and $0.39 per diluted share in the third quarter of 2019. A reconciliation of GAAP to non-GAAP financial results appears at the end of this press release.
Commented Balu Balakrishnan, president and CEO of Power Integrations: “Third-quarter revenues exceeded our expectations as we saw continued growth in fast charging for mobile devices as well as improved demand from the appliance market. Distribution sell-through strengthened considerably compared to the prior quarter, and we expect healthy sequential revenue growth in the fourth quarter.
At the midpoint of our fourth-quarter revenue range, we would achieve double-digit revenue growth for the full year.”
Power Integrations paid a cash dividend of $0.11 per share (post-split) on September 30, 2020. The company will pay another dividend of $0.11 per share on December 31, 2020 to stockholders of record as of November 30, 2020.
The company issued the following forecast for the fourth quarter of 2020:
Revenues are expected to be $130 million plus or minus $5 million.
GAAP gross margin is expected to be approximately 49 percent, and non-GAAP gross margin is expected to be approximately 50 percent. (The difference between the expected GAAP and non-GAAP gross margins comprises approximately 0.6 percentage points from amortization of acquisition-related intangible assets and 0.4 percentage points from stock-based compensation.)”
POWI closed a recent gap on the news, a pattern that is generally considered bullish.
The stock is now near new highs and a breakout could push the price towards a target of $70 based on the recent consolidation.
A Specific Trade for POWI
For POWI, the December options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A December $60 call option can be bought for about $4.80 and the December $65 call could be sold for about $2. This trade would cost $2.80 to open, or $280 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $280.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in POWI, the maximum gain is $220 ($65- $60= $5; 5- $2.80 = $2.20). This represents $220 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $280 to open this trade.
That is a potential gain of about 78% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying POWI could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.