A Business Change Hurts Revenue, and the Stock Jumps
Earnings reports are predictable in the sense that they can create volatility in a stock. They are unpredictable in the sense that the direction of the volatility is impossible to determine in advance.
For example, consider a company that makes an acquisition and then a large customer of the acquired company quits doing business with them because of the acquisition. At first glance, that sounds bad and it would be logical to expect the company’s stock price to fall. But, that’s not what happened.
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Pandora Loses a Customer
According to Market Realist, “Pandora’s (NYSE: P) programmatic audio advertising solution is now generally available following a limited-time trial with a limited number of marketers. Rolling out programmatic audio ads is another step that Pandora has taken to meet the evolving needs of markets.”
Pandora Media, Inc. is a music discovery platform, offering a personalized experience for each of its listeners wherever and whenever they want to listen to music, whether through earbuds, car speakers or live on stage.
The company delivers targeted messages to its listeners using a combination of audio, display and video advertisements. Its segments include Pandora-Internet Radio Service and Ticketfly, a cloud ticketing platform for live events working with venues and event promoters across North America.
Pandora offers advertising supported service and subscription service, Pandora Plus.
The advertising side of the business suffered some problems in the most recent quarter. “The company already offered programmatic display and video ads, so the addition of audio expands its programmatic ads solutions.
Pandora launched programmatic audio ads in February, drawing interest from about two dozen brands, including Procter & Gamble and Sony Pictures. Pandora’s programmatic audio solution leverages the technology the company acquired through its purchase of AdsWizz.
Spotify decided to end its relationship with AdsWizz after the startup was sold to Pandora.”
Spotify’s decision compounded Pandora’s advertising problems. The chart below shows the revenue realized from advertising on Pandora.
Source: Market Realist
In the most recent quarter, advertising revenues fell 2.6% compared to the same three months a year ago. This decline comes at a time when other companies are growing their advertising revenue.
Spotify reported a 20% year over year increase in advertising revenues for the most recent quarter. The giants in the industry also reported gains of at least 20% with Twitter’s ad revenue up 23%; Alphabet, parent company of Google up 23.8% and Facebook up 42%.
But, Pandora Beat Expectations
While the results in the advertising division disappointed, Pandora beat expectations. Pandora reported a loss of $0.15 per share on revenue of $384.8 million. Analysts had expected a loss of $0.16 on revenues of $372.8 million.
The stock price jumped on the news.
This could be a breakout to the up side based on the chart pattern and traders could continue buying P.
A Trade for Short Term Bulls
As with the ownership of any stock, buying P 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 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.
A Specific Trade for P
For P, the January 18 options allow a trader to gain exposure to the stock.
A January 18 $10 call option can be bought for about $0.62 and the January 18 $12 call could be sold for about $0.22. This trade would cost $0.40 to open, or $40 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 $40.
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 P the maximum gain is $1.60 ($12 – $10 = $2.00; $2.00 – $0.40 = $1.60). This represents $160 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $40 to open this trade.
That is a potential gain of about 200% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.