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A Strong Foundation Could Deliver a Triple Digit Gain In This Stock

A Strong Foundation Could Deliver a Triple Digit Gain In This Stock

Trade summary: A bull call spread in The Middleby Corporation (Nasdaq: MIDD) using the June $65 call option which can be bought for about $5.70 and the June $75 call could be sold for about $2.00. This trade would cost $3.70 to open, or $370 since each contract covers 100 shares of stock.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $3.70. The maximum gain is $630 per contract. That is a potential gain of about 170% based on the amount risked in the trade.

Now, let’s look at the details.

MIDD has been forming a basing pattern for some time.

MIDD daily chart

A recent earnings report could be the catalyst to push the stock out of the narrow range that has defined trading for the past few weeks.

MIDD is engaged in the design, manufacture and sale of commercial foodservice, food processing equipment and residential kitchen equipment.

The company operates in three segments: the Commercial Foodservice Equipment Group, the Food Processing Equipment Group and the Residential Kitchen Equipment Group.

It is also engaged in the design, manufacture, marketing, distribution and service of a range of foodservice equipment used in commercial restaurants and institutional kitchens; food preparation, cooking, baking, chilling and packaging equipment for food processing operations, and kitchen equipment, including ranges, ovens, refrigerators, ventilation and dishwashers used in the residential market.

It manufactured and assembled the equipment at 28 facilities in the United States, and 23 international manufacturing facilities. Its brands include Anets, Beech, Blodgett, Blodgett Combi, Stewart Systems, Mercury, Rangemaster, Rayburn and Redfyre.

Business Wire announced that MIDD reported net earnings for the 2020 first quarter of $73.8 million or $1.33 diluted earnings per share on net sales of $677.5 million.

Net sales decreased 1.4% in the first quarter of 2020 over the comparative prior year period. Excluding the impacts of acquisitions and foreign exchange rates, sales decreased 5.9% in the first quarter, reflecting the impact of COVID-19.

Recent acquisitions contributed 5.2% of an increase to the first quarter, while the impact of foreign exchange rates on foreign sales translated into U.S. Dollars decreased net sales by approximately 0.6%.

A decline in net sales at the Commercial Foodservice Group reflects the impact of COVID-19, initially affecting business in China, but also impacting shipments in North America with a temporary production shutdown late in the quarter for employee safety.

Residential sales reflect weakness in the UK market associated with Brexit and COVID-19.

Management noted that “Our restaurant customers have been significantly impacted due to restrictions on foodservice establishments and shelter at home orders.

Accordingly, in our Commercial Foodservice segment we have seen an approximate 65% decline of incoming orders in April compared to 2019 orders. While the continuing impact remains unpredictable, the restaurant industry has reported sales improvements every week during the month of April, from the sharp decline beginning in mid-March.

We anticipate new restaurant openings will be severely impacted for the remainder of the year, but historically most of our sales in this segment are equipment replacement and upgrades in conjunction with new menu initiatives or operational improvements.

During this crisis, our foodservice customers have focused on their delivery, drive-through and carry-out business. We are able to support these customers with innovative products and technology solutions to address workplace safety, evolving business needs and continued operating essentials. Our strategic investments over the past year have well-positioned us for current industry trends, which we expect to accelerate as our foodservice customers adopt a new work environment.”

“At our Residential Kitchen businesses, in both the U.S. and UK markets, the impact of COVID-19 included significant closures of our residential dealers’ retail sales locations and substantial decline in traffic resulting from shelter at home orders.

The decline in incoming order rates for the month of April amounted to approximately 53%. Although demand will continue to be adversely impacted and uncertain, we may see a positive benefit as dealer retail locations will begin to re-open in May.”

These comments offer insights into how the economy could fare in general and are relatively optimistic. The stock could bounce if expectations are met off a base that has formed in the last few weeks.

MIDD weekly chart

A Specific Trade for MIDD

For MIDD, the June 19 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.

A June 19 $65 call option can be bought for about $5.70 and the June 19 $75 call could be sold for about $2.00. This trade would cost $3.70 to open, or $370 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 $370.

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 MIDD, the maximum gain is $6.30 ($75- $65= $10; 10- $3.70 = $6.30). This represents $630 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $370 to open this trade.

That is a potential gain of about 170% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

A Trade for Short Term Bulls

As with the ownership of any stock, buying MIDD 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  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.

bull call spread

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.