After the Earnings Announcement, an Opportunity for a 70% Gain Appears
Trade summary: A bull call spread in CareDx, Inc (Nasdaq: CDNA) using the November $55 call option which can be bought for about $4.60 and the November $60 call could be sold for about $2.75. This trade would cost $1.85 to open, or $185 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 $185. The maximum gain is $315 per contract. That is a potential gain of about 70% based on the amount risked in the trade.
Now, let’s look at the details.
CDNA describes itself as “a leading precision medicine company focused on the discovery, development, and commercialization of clinically differentiated, high-value healthcare solutions for transplant patients and caregivers.” The company recently announced preliminary unaudited revenue for the three months ended September 30, 2020.
Preliminary revenue for the three months ended September 30, 2020 is expected to be approximately $53.0 million, an increase of 57% compared with $33.8 million in the third quarter of 2019. Testing revenue for the quarter is expected to be approximately $45.2 million, compared with $28.2 million in the same period in 2019.
Total AlloSure and AlloMap patient results provided in the quarter were approximately 21,800. Product revenue in the three months ended September 30, 2020 is expected to be $5.4 million, compared to $4.2 million in the same period in 2019. Digital & other revenue in the third quarter of 2020 is expected to be $2.4 million, compared to $1.4 million in the same period in 2019.
The preliminary information presented in this press release is based on CareDx’s current expectations and may be adjusted as a result of, among other things, completion of customary quarterly review procedures.
“I am proud of the CareDx team for rising above the continued challenges of the pandemic and partnering with transplant centers to support transplant patients throughout these uncertain times,” said Peter Maag, Chairman and CEO of CareDx, Inc.
“Our strong third quarter performance was driven by this dedication and our commitment to lead in advancing transplantation, underscored by our surveillance solutions, AlloSure and AlloMap.”
“We continue to invest in growth initiatives to position CareDx as the leader in transplantation and expand our pipeline, including most recently with patient care management and digital solutions,” said Reg Seeto, President and Chief Business Officer.
“As a result of our strategic investments, we have been able to adapt more efficiently to meet the needs of individual transplant centers during this pandemic and to attract incredible talent to join the CareDx team.”
The stock broke out on the news.
The long-term chart shows the breakout clears resistance and the stock could move substantially higher as momentum traders consider the trade.
A Specific Trade for CDNA
For CDNA, the November 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 November $55 call option can be bought for about $4.60 and the November $60 call could be sold for about $2.75. This trade would cost $1.85 to open, or $185 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 $185.
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 CDNA, the maximum gain is $315 ($60- $55= $5; 5- $1.85 = $3.15). This represents $315 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $185 to open this trade.
That is a potential gain of about 70% 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 CDNA 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 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.
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.