A Shocking Name on the Biggest Losers List
Everyday, some traders look at the list of stocks with big moves for potential trades. This is often a useful strategy, especially for short term traders, because sometimes names on those lists will be starting trends while at other times they are likely to enjoy a short countertrend move.
Daily lists of large winners and losers often include relatively small stocks. After all, it is much easier for a company with a market capitalization of $100 million to move 10% than it is for a company with a market capitalization of more than $92,500 billion.
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That means when a large cap company is among the day’s biggest gainers or losers, traders should take notice and consider the stock as a trading opportunity.
Philip Morris Surprises Investors
Philip Morris International Inc. (NYSE: PM) is the company that sells Marlboros and other popular brands of cigarettes outside the U.S. In the most recent quarter, the company reported revenue of $6.9 billion, less than the $7.03 billion that analysts surveyed by Bloomberg had been projecting.
The stock sold off as much as 15 percent in early trading on Thursday.
Philip Morris has been moving to counter a decline in global smoking rates by boosting prices and introducing new products. But, that didn’t prevent the company’s cigarette shipments from falling by 5.3% in the first quarter of the year.
The company is betting on less harmful products and has developed four “platforms” it says are less harmful than cigarettes. Chief Executive Officer Andre Calantzopoulos has said he envisions a world where all 1 billion smokers have switched to reduced-risk nicotine delivery systems.
The first, called iQos, heats a tobacco plug without setting it on fire. IQos was available in 38 markets as of February.
Platform 2 was introduced in a city test in the Dominican Republic in December. That product, called TEEPS, is a second heat-not-burn offering that resembles a regular cigarette with a tip that prevents it from setting on fire.
The company plans to launch a consumer test for the third platform, a nicotine inhaler, this year, and it expects to release a next-generation version of Platform 4, an e-vapor offering.
These products are expected to help the company later this year and management raised its earnings guidance for 2018 by $0.05 to between $5.25 and $5.40.
Technical Patterns Point to Additional Weakness
The weekly chart of the stock price shows that the decline wiped out more than a year’s worth of gains in the stock.
The pattern is clearer on a monthly chart that shows the price action back to 2008 when PM was separated from Altria which focuses on sales in the United States.
This shows what appears to be a significant topping pattern. A decline to $65 would be reasonable based on the chart pattern. Interestingly, this would bring the stock to a level where the price to earnings (P/E) ratio would be about 12, a level some analysts consider appropriate for a mature company with slow growth prospects like PM.
A Trading Strategy While Awaiting Better News
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook, a call option should be sold.
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 is important to consider is the bear call spread. This trade 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, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy 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.
A Bear Call Spread in PM
For PM, we have a number of options available. Short term options allow us to trade frequently and potentially expand our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell an May 18 $90 call for about $1.00 and buy an May 18 $92.50 call for about $0.40. This trade generates a credit of $0.60, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $60. The credit received when the trade is opened, $0.60 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $190. The risk is 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 ($60).
This trade offers a potential return of about 32% of the amount risked for a holding period that is about one month. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if PM is below $90 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 $190 for this trade in PM.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.