A Short-Term Opportunity to Capture a 200% Gain
It’s a volatile market and the volatility has been so high lately that a number of trading opportunities are appearing in the options markets. Among them is a short term opportunity in Acuity Brands Inc. (NYSE: AYI).
This stock is well above its December lows and analysts at ZACKS noted that gains could continue:
AYI’s innovative lighting control solutions and energy-efficient luminaries are substantial growth drivers for the company’s overall performance.
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Recently, the company reported first-quarter fiscal 2019 results, wherein both the top and bottom lines surpassed the Zacks Consensus Estimate by 0.1% and 7.4%, respectively. Also, the reported figure increased 10.7% and 19.6% on year-over-year basis.
Its robust performance was backed by higher demand for small and medium-sized lighting solutions.
Factors Driving Growth
“Product Innovation: Acuity Brands is highly focused on expanding its portfolio of innovative lighting control solutions and energy-efficient luminaries. The company introduces new products and capitalizes on market opportunities in order to drive sales growth.
Notably, in the first quarter of fiscal 2019, net sales improvement of 10.7% was primarily driven by volume growth in its Contractor Select portfolio, Atrius-enabled luminaires and Holophane solutions.
Overall, the company witnessed solid growth in most channels and geographies. Sales volume in the fiscal first quarter grew approximately 11% year over year, backed by continued efforts to expand its customer base, along with the introduction of new products and solutions.
Cost-Saving Initiatives: The company has been undertaking various cost-saving initiatives that are expected to offset higher input cost as well as the impact of tariffs. These actions include price increases and reduction in other costs.
During the fiscal first quarter, the company announced two price increases in order to offset the negative impact of higher material cost. Adjusted gross profit margin during the fiscal first quarter grew 60 basis points (bps) sequentially.
Moreover, the company remains confident about its initiatives to drive long-term growth.
Expansion Via Acquisitions: Acuity Brands is expanding its geographic borders and product portfolio through acquisitions and joint ventures. Acquisitions (net of divestitures) added 1% to its total revenues in the fiscal first quarter.
In fiscal 2018, the company spent $163 million on acquisitions, namely Lucid Design Group and IOTA Engineering. Being an industry leader in emergency lighting and power equipment for commercial and institutional applications, IOTA will enhance its market leadership in this important lighting category.”
This could mean the recent bottom in the stock, which came at a support level, could mark a buying opportunity.
A Trade for Short Term Bulls
As with the ownership of any stock, buying AYI 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 prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for AYI
For AYI, the January 18 options allow a trader to gain exposure to the stock.
A January 18 $125 call option can be bought for about $1.60 and the January 18 $130 call could be sold for about $0.40. This trade would cost $1.20 to open, or $165 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 $120.
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 AYI the maximum gain is $3.80 ($130 – $125 = $5.00; $5.00 – $1.20 = $3.80). This represents $380 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $120 to open this trade.
That is a potential gain of about 216% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.