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A Potential 133% Gain with Defined Risk of Less Than $200

A Potential 133% Gain with Defined Risk of Less Than $200

News can highlight opportunities. As Business Wire reported, ResMed (NYSE: RMD) reported earnings. The stock jumped on the news.

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  • RMD daily chart

    Business Wire noted,

    “Revenue increased 16% to $681.1 million; up 17% on a constant currency basis. Gross margin expanded 120 bps to 59.5%. Net operating profit increased 19%; non-GAAP operating profit up 22%. GAAP diluted earnings per share of $0.83; non-GAAP diluted earnings per share of $0.93.

    “Our global ResMed team delivered another quarter of strong performance in the first quarter of fiscal year 2020 with double-digit topline revenue growth, balanced growth across our businesses and regions, and further improvements in operating leverage resulting in double-digit growth at the bottom line,” said Mick Farrell, ResMed’s CEO.

    “We were particularly pleased that strong customer demand for our new products drove high-teens growth in the mask category during the quarter.

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  • Through organic growth and targeted acquisitions, we’re driving forward every facet of our business, leading the innovation of devices and software that improve health outcomes, create efficiencies, and reduce overall healthcare system costs.

    We’re well on our way to improving 250 million lives in out-of-hospital healthcare in 2025.”

    Revenue in the U.S., Canada, and Latin America, excluding Software as a Service, grew by 13 percent compared to the prior year period, driven by strong sales across our mask and device product portfolios.

    Revenue in combined Europe, Asia and other markets grew by 8 percent on a constant currency basis compared to the same period of the prior year. Mask sales were strong across these markets.

    As expected, device sales in France and Japan were impacted as customers manage their fleets following the completion of their connected device upgrade programs. Device sales outside France and Japan grew well.

    Software as a Service revenue increased by 83 percent, compared to the prior year period, due to continued growth in Brightree service offerings and incremental contribution from the acquisition of MatrixCare, which closed in the second quarter of fiscal year 2019.

    Gross margin expanded by 120 basis points over the prior year period, primarily due to benefits from manufacturing and procurement efficiencies, and higher margin contribution from MatrixCare.

    Selling, general, and administrative expenses increased by 14 percent compared to the prior year period, or by 16 percent on a constant currency basis. Excluding the impact of recent acquisitions, selling, general, and administrative expenses increased by 6 percent on a constant currency basis.

    SG&A expenses improved to 24.6 percent of revenue in the quarter, compared with 25.0 percent in the same period of the prior year.

    Income from operations increased by 19 percent and non-GAAP income from operations increased by 22 percent compared to the prior year period.

    Net income and diluted earnings per share both grew by 14 percent, predominantly attributable to strong sales, particularly in masks, coupled with controlled operating costs compared to the prior year quarter.

    Non-GAAP net income grew by 16 percent and non-GAAP diluted earnings per share grew by 15 percent compared with the prior year quarter.

    Cash flow from operations for the quarter was $162.4 million, compared to net income in the current quarter of $120.1 million. During the quarter we paid $56.1 million in dividends.

    The stock broke out to new highs on the longer term chart.

    RMD weekly chart

    A Trade for Short Term Bulls

    As with the ownership of any stock, buying RMD 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 RMD

     Every day, we scan the markets looking for trades with 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 RMD, the December 20 options allow a trader to gain exposure to the stock.

    A December 20 $145 call option can be bought for about $4.10 and the December 20 $150 call could be sold for about $2.60. This trade would cost $1.50 to open, or $150 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 $150.

    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 RMD the maximum gain is $3.50 ($150 – $145= $5; $5 – $1.50 = $3.50). This represents $350 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $150 to open this trade.

    That is a potential gain of about 133% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

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