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An Earnings Beat Highlights a Potential Gain of 254%

An Earnings Beat Highlights a Potential Gain of 254%

Earnings news can attract attention of investors and analysts. One example, The Street recently reported, is in this news story. “Analysts were scrambling to boost their price targets on Fortinet (Nasdaq: FTNT) after the cybersecurity software company blew past analysts’ expectations with a third-quarter growth surge.

Analysts at Mizuho Securities, BMO Capital and Cowen all hiked their price targets on Fortinet.”

FTNT daily chart

Fortinet, Inc. is a network security company.

The company provides cyber security solutions to a range of enterprises, service providers and government organizations across the world. Its network security solution consists of FortiGate physical, virtual machine and cloud platforms, which provide integrated security and networking functions to protect data, applications and users from network-and content-level security threats.

The company’s product offerings consist of its FortiGate product family, along with its FortiManager central management and FortiAnalyzer central logging and reporting product families. Its cybersecurity platform includes a range of products, which include its FortiMail e-mail security, FortiSandbox advanced threat protection (ATP), FortiWeb Web application firewall, FortiDDos and FortiDB database security appliances, as well as its FortiClient endpoint security software, FortiAP secure wireless access points and FortiSwitch secure switch connectivity products.

The Street continued,

“… the company reported quarterly earnings of 67 cents a share, beating the estimate of 56 cents a share of analysts surveyed by Zacks Investment Research.

BMO Capital lifted its price target to $104 a share, up from $100, placing a market perform rating on Fortinet’s stock.

Mizuho hiked its price target to $92 a share, up from $86, with a neutral rating on the stock, while Cowen bumped its target to $88 from $85, with a market perform rating

Analysts at BMO called Fortinet’s third-quarter numbers “solid across the board.” And while billings growth cooled, the company’s overall growth rate was “nonetheless impressive vs. the current valuation.”

Cloud, SD-WAN and Fortinet Security Fabric products helped drive a 21% jump in growth during the third quarter, with revenue rising to $547.5 million, up from $453.9 million during the same period a year ago, the company said.

Cowen analysts wrote they were “encouraged by the building momentum across FTNT’s portfolio.” Fortinet also has a “sizable opportunity” over the next few years for its SD-WAN technology, though slowing demand for security equipment may also has to be factored in, analysts at the firm cautioned.”

The weekly chart shows the stock is approaching resistance.

FTNT weekly chaart

A Trade for Short Term Bulls

As with the ownership of any stock, buying FTNT 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 has 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.

A Specific Trade for FTNT

Every day, we scan the markets looking for trades with 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.

For FTNT, the December 20 options allow a trader to gain exposure to the stock.

A December 20 $95 call option can be bought for about $1.85 and the December 20 $100 call could be sold for about $0.75. This trade would cost $1.10 to open, or $110 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 $110.

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 FTNT the maximum gain is $3.90 ($100 – $95 = $5; $5 – $1.10 = $3.90). This represents $390 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $110 to open this trade.

That is a potential gain of about 254% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.