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An Analyst Highlights a Possible Gain of 190%

An Analyst Highlights a Possible Gain of 190%

Trade summary: A bull call spread in Sunrun Inc. (Nasdaq: RUN) using the August $35 call option which can be bought for about $2.50 and the August $40 call could be sold for about $1.22. This trade would cost $1.28 to open, or $128 since each contract covers 100 shares of stock.

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  • In this trade, the maximum loss would be equal to the amount spent to open the trade, or $128. The maximum gain is $372 per contract. That is a potential gain of about 190% based on the amount risked in the trade.

    Now, let’s look at the details.

    The solar industry is attracting the attention of analysts as Barron’s notes, “The residential solar-power companies Sunrun and Vivint Solar said [recently] that they plan to merge, an announcement that sent both stocks flying. [In subsequent days], they were jumping again after an analyst upgraded the shares.

    KeyBanc Capital Markets analyst Sophie Karp boosted her rating on shares of Sunrun (RUN) to Overweight, with a $32 price target. She increased her target for Vivint [as well].

    RUN daily chartThe two companies are the No. 1 and No. 2 solar installers in the country, so their consolidation would give them a strong foothold in an industry that is otherwise fragmented. Karp estimated that their market share within the industry will be some 23% to 26% once the deal is complete.

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  • That is expected to happen in the fourth quarter of this year.

    Karp’s bullish thesis is based on a few factors, some of which other analysts have also discussed. For one thing, the two companies expect to reduce their costs, saying they can achieve $90 million worth of “synergies.”

    At the same time, the new company will have a more diverse asset base and may be able to expand into new areas more easily. The shares will also be more liquid.

    Two other rationales for the upgrade also stand out. There are limited ways for investors to bet on clean energy, an area with strong growth prospects and a clear ESG rationale. Sunrun, now a smallish midcap company, would become larger after the merger and potentially attract new investors. “Sunrun would represent one of the few investable clean energy names that is in demand with multiple classes of investors,” Karp wrote.

    And Sunrun could attract its own suitors. A larger company looking to enhance its green profile could be attracted to the combined business, which would now have much more sizable market share.”

    With the recent gains, RUN is above resistance. The breakout completes a consolidation that points to a possible price target in the mid $30s.

    RUN weekly chart

    A Specific Trade for RUN

     For RUN, the August 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.

    An August $35 call option can be bought for about $2.50 and the August $40 call could be sold for about $1.22. This trade would cost $1.28 to open, or $128 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 $128.

    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 RUN, the maximum gain is $372 ($40- $35= $5; 5- $1.28 = $3.72). This represents $372 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $128 to open this trade.

    That is a potential gain of about 190% 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 RUN 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.

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