A Turnaround Could Be Near for This Icon
Source: Harley Davidson.com
It’s impossible to predict which companies will achieve an iconic position in culture. But, it’s indisputable that some companies have an impact on the culture. McDonald’s is one, as is Starbucks. Both are companies with clear images in the minds of consumers.
Another iconic company is Harley-Davidson, Inc. (NYSE: HOG). The company doesn’t just make motorcycles. As they explain,
“We fulfill dreams of personal freedom – it’s our purpose, and we take it seriously. And while freedom means different things to different people, it’s a bond that brings Harley-Davidson customers, employees, dealers, suppliers and enthusiasts together.”
This is a company that thinks of itself as a part of the culture. The web site, as most corporate web sites do, includes pictures of the leadership team. But, there’s something different about Harley-Davidson’s management photos.
There are no suits and ties. This is a company that expresses their vision in their lifestyle choices.
A Turnaround Could Be Starting
The company has been struggling for the past few years. Sales of $5.7 billion in the past twelve months are about where they were in 2012 when sales were $5.6 billion for the full year. Revenue peaked in 2014 at $6.2 billion.
Earnings per share (EPS) growth has been driven largely by share buy backs. This is to be expected when sales stagnate for any company. In the case of HOG, the company has bought back about 27% of its outstanding shares over the past seven years.
The stock chart shows the struggles of the company.
The stock has been declining and in a trading range for the past few years. However, last week the stock delivered a strong gain after traders noticed that a potential trade war could have little impact on the company.
HOG requires steel and a number of imported parts. Analysts believe, “The company will likely see higher costs from previously announced tariffs on aluminum and steel and may see lower sales as the European Union considers retaliatory tariffs on motorcycles.”
Traders were relieved that the recent “ $50 billion tariff announcement was more focused on high-tech industrial products like machinery for making light bulbs and aerospace tariffs. They won’t likely hurt Harley-Davidson’s top or bottom line in the near future.”
But, the daily chart shows that the stock may not rally much further from its recent level.
There is significant resistance and the company will need to report stronger financials to prove that its operations are turning around. The next earnings report is expected in late July and the stock could remain range bound until then.
The stock is trading at levels that could be attractive to value investors. The stock is priced at about 12.8 times this years expected EPS of $3.40. Combined with a dividend yield of about 3.4%, it seems safe to say that HOG is the kind of stock that long term investors would like to own, assuming the decline is over.
While awaiting proof that operations are on track, traders could still find the stock to be attractive.
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 HOG
For HOG, 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 a July 20 $47.50 call for about $0.65 and buy a July 20 $50 call for about $0.15. This trade generates a credit of $0.50, 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 $50. The credit received when the trade is opened, $50 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $200. 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 ($50).
This trade offers a potential return of about 25% 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 HOG is below $47.50 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 $200 for this trade in HOG.
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.