An Earnings Beat Creates a Triple Digit Opportunity in a Tech Stock
Trade summary: A bull call spread in F5 Networks, Inc. (Nasdaq: FFIV) using the May 15 $145 call option which can be bought for about $4.50 and the May 15 $150 call could be sold for about $2.15. This trade would cost $2.35 to open, or $235 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 $2.35. The maximum gain is $265 per contract. That is a potential gain of about 112% based on the amount risked in the trade.
Now, let’s look at the details.
F5 Networks, Inc. is a developer and provider of software defined application services.
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The Company is engaged in the development, marketing and sale of application delivery networking products that optimize the security, performance and availability of network applications, servers and storage systems.
The Company’s Traffic Management Operating System (TMOS) based offerings include software products for local and global traffic management, network and application security, access management, Web acceleration and various network and application services.
These products are available as modules that can run individually or as part of an integrated solution on the Company’s purpose-built BIG-IP appliances and VIPRION chassis-based hardware, or as software-only Virtual Editions.
Recently the company reported earnings and Zacks reported the company posted “non-GAAP earnings per share of $2.23. The company’s quarterly earnings came in significantly higher than its guidance of $2.14-$2.16 per share.
Non-GAAP earnings fell 13.2% from the year-ago quarter as elevated operating expenses more than offset the benefit of higher revenues.
Revenues increased 7% year over year to $583.4 million, surpassing the Zacks Consensus Estimate of $566 million on solid software growth. Also, revenues came in at the mid-point of the company’s $580-$590 million guided range.”
The stock was up on the news.
Zacks continued, “During the earnings conference call, the company stated that the coronavirus outbreak had a neutral impact on its business. F5 Networks witnessed minimal business disruptions during the first two-and-a half months outside of Asia.
During the last 15 days of the quarter, the firm witnessed increased purchases from some customers in a bid to strengthen their application infrastructure. However, some clients push-out their technological upgradation projects, which neutralize the aforementioned tailwinds.
Citing business uncertainties due to the pandemic, the company withdrew its fiscal 2020 outlook. However, it has issued a guidance for the fiscal third quarter.
For the fiscal third quarter, F5 Networks expects non-GAAP revenues in the range of $555-$585 million. The Zacks Consensus Estimate for revenues is pegged at $559.9 million.
The company anticipates non-GAAP earnings per share in the $1.91-$2.13 band. The Zacks Consensus Estimate is pinned at $1.88.
The company expects to incur operating expenses of $320-$332 million, including the Shape acquisition-related expenses.
Management remains optimistic that surging demand for multi-cloud application services will be a key driver. “
The stock appears to be bouncing strongly off recent lows, forming a V-bottom.
A Specific Trade for FFIV
For FFIV, the May 15 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 May 15 $145 call option can be bought for about $4.50 and the May 15 $150 call could be sold for about $2.15. This trade would cost $2.35 to open, or $235 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 $2.35.
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 FFIV the maximum gain is $2.65 ($150- $145= $5; 5- $2.35 = $2.65). This represents $265 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $235 to open this trade.
That is a potential gain of about 112% 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 FFIV 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 FFIV 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.