A Large Cap Jumps on an Earnings Beat
Many traders look at small cap stocks with low prices for gains. It’s also possible to find gains in large cap stocks at low prices, especially when traders consider options strategies. An example of this strategy can be seen in Clorox (NYSE: CLX).
Earnings Lead to a Rally
The company’s reaffirmed full-year guidance was a welcomed relief after weakness in 2018 (although Clorox had a better year than many of its consumer staples peers.)
Once steady growers, consumer staples companies have struggled to adapt to changing consumer preferences for local and greener alternatives, while lumpy growth in emerging markets and the strong dollar has hurt multinational players.
Clorox was one of the stocks that was crushed after reporting earnings last fall, leading to questions about whether or not staples and safety were still synonymous. The brutal fourth-quarter selloff hit the sector hard, demonstrating that even nervous risk-averse investors were choosing to hide elsewhere.”
ZACKS added the details of the earnings report.
Quarterly earnings from continuing operations of $1.40 per share increased 2.2% year over year and surpassed the Zacks Consensus Estimate of $1.32. The bottom-line improvement was mainly backed by a lower tax rate along with higher sales and gains from cost savings.
Net sales of $1,473 million advanced 4% year over year but marginally missed the Zacks Consensus Estimate of $1,479 million. The year-over-year improvement in the top line was driven by solid execution of pricing and cost-saving plans.
Additionally, the company’s sales benefited from a contribution of 4 percentage points from the Nutranext acquisition. However, these gains were partly compensated by negative impact of 3 percentage points from foreign currency.
Gaining from recent price increases and cost savings, Clorox witnessed gross margin expansion of 70 bps to 43.7% in the fiscal second quarter. However, the aforementioned gains were partly negated by elevated commodity as well as manufacturing and logistics expenses.
This is unlike most of the company’s peers, who are witnessing gross margin declines due to increased raw material and commodity costs. Notably, Procter & Gamble PG and Colgate-Palmolive CL reported gross margin declines of 80 basis points (bps) and 100 bps, respectively, in the last reported quarter.
Clorox reiterated its guidance for fiscal 2019. The company continues to project sales growth of 2-4% from the fiscal 2018 level. The improvement will be backed by innovations that are likely to deliver about 3 percentage points of additional sales.
The top line is also likely to reflect the combined positive effect of the Nutranext acquisition and the Aplicare divestiture to the tune of 3 percentage points. However, top-line growth guidance includes negative impact of about 3 percentage points from currency rates.
Gross margin is estimated to remain flat in fiscal 2019 as gains from higher prices and cost-savings efforts are expected to be offset by increased costs and adverse foreign currency exchange rates.
Zack’s concludes, “Consequently, for fiscal 2019, management anticipates earnings per share of $6.20-$6.40 from continuing operations.
Notably, earnings projection includes nearly 8-12 cents from the Nutranext acquisition. It also includes negative impact of nearly 5-7 cents from tariffs, which are hurting certain business segments. The Zacks Consensus Estimate for fiscal 2019 is pegged at $6.32.”
This news could push the stock out of its recent consolidation.
A Trade for Short Term Bulls
As with the ownership of any stock, buying CLX 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 CLX
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.
For CLX, the April 18 options allow a trader to gain exposure to the stock.
An April 18 $155 call option can be bought for about $5.05 and the April 18 $160 call could be sold for about $2.90. This trade would cost $2.15 to open, or $215 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 $215.
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 CLX the maximum gain is $2.85 ($165 – $160 = $5; $5 – $2.15 = $2.85). This represents $285 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $215 to open this trade.
That is a potential gain of about 32% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.