A Bullish Chart Points to a Possible 80% Profit for Investors
Trade summary: A bull call spread in General Mills, Inc. (NYSE: GIS) using the April 17 $52.50 call option which can be bought for about $1.80 and the April 17 $55 call could be sold for about $0.91. This trade would cost $0.89 to open, or $89 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 $89. The maximum gain is $161 per contract. That is a potential gain of about 80% based on the amount risked in the trade.
Now, let’s look at the details.
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So far, the company has been focused in meeting increased demand for its products which include a large number of shelf-stable food. On CNBC last week, the company’s CEO said everyone “is “doing the job they need to do.”
The company is adapting to the current environment and making a slight shift in its operating philosophy in response to the coronavirus.
“General Mills is altering its mission slightly from “making food the world loves” to “making food the world needs,” the CEO said.
The company is seeing a growing demand for “in-home” food categories, like soup, cereal, yogurt, baking mixes. Many of the company’s brands are household names. And many consumers are finding ow is an ideal time to explore the company’s products including Betty Crocker and Bisquick, products that require some time but provide a diversion in the current environment.
The CNBC report indicated that in the Chinese market, for example, is showing a double-digit sales growth for “at-home” categories over the past few months.
However, the company is not seeing growth in all brands. Over the past few months, GIS reported that sales at Haagen-Dazs locations in China were down 90%, consistent with the fact about 90% of its stores in China were closed.
In recent weeks, reports indicate that a majority of shops in China have been reopened as the fear of spreading coronavirus eased. Consumers are still cautious, and the CEO noted that foot traffic is about half of its normal level. But he is pleased to see that consumers are likely to return when restrictions are eased in Europe and the United States.
In the crisis, “General Mills has been able to fulfill more than 90% of all orders at a time of heightened demand for food products, the CEO said. This wouldn’t be possible without new benefits for employees, including sick leave or to take care of children.
Overall, the food supply chain in the U.S. is “just remarkable” which gives General Mills the confidence it can continue supplying the U.S. and the world with food.”
The stock shows signs of bottoming.
The weekly chart is bullish with GIS near a breakout.
A Specific Trade for GIS
For GIS, the April 17 options allow a trader to gain exposure to the stock. This trade will be open for about four weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An April 17 $52.50 call option can be bought for about $1.80 and the April 17 $55 call could be sold for about $0.91. This trade would cost $0.89 to open, or $89 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 $89.
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 GIS the maximum gain is $1.61 ($55- $52.50= $2.50; $2.50 – $0.89 = $1.61). This represents $161 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $89 to open this trade.
That is a potential gain of about 80% 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 GIS could require a significant amount of capital and eGISses 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 usually 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 has 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.