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A Miss Creates an Opportunity

A Miss Creates an Opportunity

In a typical quarter, more than 70% of companies beat earnings expectations. That means misses are unusual and unusual events can often be traded. One such opportunity can be found in news that analysts at The Street noted, “Shares of Synchrony Financial (NYSE: SYF) were sinking [recently] after the credit card services company reported mixed fourth-quarter results.”

SYF daily chart

Synchrony Financial is a consumer financial services company. The company provides a range of credit products through programs it has established with a group of national and regional retailers, local merchants, manufacturers, buying groups, industry associations and healthcare service providers.

The company’s revenue activities are managed through three sales platforms: Retail Card, Payment Solutions and CareCredit.

It offers its credit products through its subsidiary, Synchrony Bank (the Bank). Through the Bank, it offers a range of deposit products insured by the Federal Deposit Insurance Corporation (FDIC), including certificates of deposit, individual retirement accounts (IRAs), money market accounts and savings accounts.

The company offers three types of credit products: credit cards, commercial credit products and consumer installment loans. The company also offers a debt cancellation product. It offers two types of credit cards: private label credit cards and Dual Cards.

The Street continued, “The company reported earnings of $731 million, or $1.15 a share, compared with $783 million, or $1.09, a year earlier. Adjusted earnings for the latest quarter came to $1.10 a share, beating analysts’ estimates of $1.07.

Provision for loan losses totaled $1.1 billion, missing calls for $1.25 billion. Revenue totaled $3.1 billion, short of Wall Street’s estimate for $3.15 billion.

Net interest income fell 7.3% to $4.03 billion and was related to the Walmart consumer portfolio sale.

In November 2018, Walmart filed a lawsuit against the bank that alleged it breached the terms of their long-running credit-card deal. The world’s largest retailer was seeking damages of at least $800 million. Synchrony called the suit “baseless.” In January 2019, Walmart agreed to drop the lawsuit.

Deposits were $65.1 billion, up 2% from the year-ago quarter. Provision for loan loss fell 24% year over year to $1.1 billion primarily driven by lower core reserve build and reduction in net charge-offs.

Purchase volume was flat at $40.2 billion, but up 7% on a core basis.

“2019 marked another year of significant transformation for Synchrony,” CEO Margaret Keane said in a statement.”

The news comes as the stock was near its recent highs and sets up a potential triple top pattern on the chart.

SYF weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

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.

A Bear Call Spread in SYF

For SYF, we could sell a February 21 $31 call for about $2.41 and buy a February 21 $33.50 call for about $1.69. This trade generates a credit of $0.72, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $72. The credit received when the trade is opened, $72 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $178. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($72).

This trade offers a potential return of about 40% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if SYF is below $31 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $178 for this trade in SYF.