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An Earnings Beat, a Sell Off and a Trading Opportunity

An Earnings Beat, a Sell Off and a Trading Opportunity

Beating earnings isn’t always enough to please investors. A recent example of a company that beat estimates by a penny but sold off more than 14% shows how traders can find income in big moves.

According to Zacks, “TriNet Group (NYSE: TNET) came out with quarterly earnings of $0.81 per share, beating the Zacks Consensus Estimate of $0.80 per share. This compares to earnings of $0.76 per share a year ago. These figures are adjusted for non-recurring items.

This quarterly report represents an earnings surprise of 1.25%. A quarter ago, it was expected that this human resources services outsourcing company would post earnings of $0.69 per share when it actually produced earnings of $0.70, delivering a surprise of 1.45%.

Over the last four quarters, the company has surpassed consensus EPS estimates four times.

TriNet, which belongs to the Zacks Outsourcing industry, posted revenues of $221 million for the quarter ended September 2019, missing the Zacks Consensus Estimate by 1.75%. This compares to year-ago revenues of $228 million. The company has topped consensus revenue estimates three times over the last four quarters.”

The stock sold off on the news.

TNET daily chart

PR Newswire reported additional details on the earnings:

TriNet Group, Inc., a leading provider of comprehensive human resources solutions for small to midsize businesses, today announced financial results for the third quarter ended September 30, 2019.

The third quarter highlights below include non-GAAP financial measures which are reconciled later in this release.

Total revenues increased 11% to $969 million and Net Service Revenues decreased 4% to $221 million, each as compared to the same period last year.

Net income was $55 million, or $0.78 per diluted share, compared to net income of $51 million, or $0.71 per diluted share, in the same period last year.

Adjusted Net Income was $58 million, or $0.81 per diluted share, compared to Adjusted Net Income of $55 million, or $0.75 per diluted share, in the same period last year.

Adjusted EBITDA was $93 million, an 8% increase from the same period last year.

Total WSEs increased 4% compared to the same period last year, at approximately 332,000.

Average WSEs increased 4% as compared to the same period last year, at approximately 331,000.

“During the third quarter, we continued to accelerate the momentum in our business as we successfully delivered our value proposition into our installed base and to new customers,” said Burton M. Goldfield, TriNet’s President and CEO.

“We did experience higher insurance costs during the quarter, and we have already taken steps to mitigate their impact to 2020. With the current momentum in our business coupled with the steps we’ve taken, we believe we are well positioned to continue to deliver profitable growth for our shareholders.”

The long-term chart shows a potential topping pattern that indicates the decline could go deeper.

TNET weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

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 traders can consider is the bear call spread. This is a trade that 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. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It 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 and is also known.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in TNET

For TNET, we could sell a November 15 $50 call for about $1.87 and buy a November 15 $55 call for about $0.42. This trade generates a credit of $1.45, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $145. The credit received when the trade is opened, $145 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $355. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($145).

This trade in TNET offers a potential return of about 40% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if TNET is below $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 $355 for this trade in TNET.