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A Patent Case Could Make You a Winner

A Patent Case Could Make You a Winner

There are times when seemingly obscure news can lead to a trading opportunity. A recent example could be the news that BizJournals reported,

“The U.S. Patent Office rejected Taser-maker Axon Enterprise Inc.’s final challenge against a patent for an auto-activated video system held by Lenexa-based Digital Ally Inc.

Digital Ally (Nasdaq: DGLY) and Axon (Nasdaq: AAXN) have been waging a legal battle over intellectual property for about three years. Digital Ally accuses Axon of infringing on its patents for technology that activates a camera system when specified triggers occur, such as turning on emergency lights.

Digital Ally seeks about $204 million in damages, which includes treble damages for “willful” infringement. The company also seeks prejudgment and post-judgment interest on those damages, and attorney fees.

This is now the seventh failed attempt by Axon to invalidate one of Digital Ally’s patents.”

This Could Hurt AAXN

This might sound obscure, but the report continued to note that this legal saga could be important for investors in AAXN to understand:

“this particular challenge, against Patent No. 9,253,452, is key to Digital Ally’s patent infringement lawsuit. Axon first filed for an inter partes review on this patent on Dec. 20, 2016, but the U.S. Patent and Trademark Office rejected the request on July 6, 2017, stating it was deficient and didn’t warrant closer inspection.

Axon then filed a request for the Patent Office to reconsider its ruling, saying it overlooked Axon’s evidence and misapplied the law. However, the Patent Office again rejected Axon’s request, saying it was improperly using the request as “an opportunity to present new arguments or evidence.”

Axon no longer has any additional inter partes review challenges pending against Digital Ally’s auto-activation patents and is barred from filing any further challenges.

The ruling also is important for a similar case Digital Ally filed against Enforcement Video LLC (doing business as WatchGuard Video), which agreed to be bound by the results of Axon’s attempts to invalidate the patents.

“This decision represents another confirmation of the validity of our auto-activation patents,” Digital Ally CEO Stanton Ross said in a release.

“To date, every court and every judge that has examined the validity of these auto-activation patents has confirmed their strength and found them valid. The finish line is finally near and we look forward to a jury confirming what we have alleged all along; Taser has willfully infringed our ‘452 Patent and is benefiting in the marketplace at our expense.”

The ongoing patent infringement and legal battle took a toll on Digital Ally. The company was forced to cut about 40 percent of its workforce in early 2018. Digital Ally was forced to submit filings with the Securities and Exchange Commission indicating that the company had doubts about its ability to continue as a going concern and that the board was reviewing its strategic alternatives.”

While it may take time for DGLY, it seems as if traders are concerned about AAXN as well with the stock falling on the news.

AAXN daily chart

The longer term chart shows that AAXN was once a high flier and is now in a down trend and that could offer a trading opportunity to short term traders.

AAXN weekly

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

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 AAXN

For AAXN, we could sell an April 18 $50 call for about $1.80 and buy an April 18 $55 call for about $0.65. This trade generates a credit of $1.15, 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 $115. The credit received when the trade is opened, $115 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $385. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($115).

This trade offers a potential return of about 30% 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 AAXN is below $50 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 $385 for this trade in AAXN.

For more information on options click here for our free guide, The Ultimate Guide to Options Trading.