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An Earnings Beat Sets Up a Trading Opportunity

An Earnings Beat Sets Up a Trading Opportunity

State Street Corp (NYSE: STT) recently reported adjusted earnings of $1.51 per share, which beat the Zacks Consensus Estimate of $1.40.

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  • Cost saving efforts supported the results. The stock was up on the news.

    STT daily chart

    Business Wire reported,

     “Ron O’Hanley, President and Chief Executive Officer  said “We are encouraged by the continued stabilization in servicing fees seen in the third quarter and believe the actions we’ve taken to date, including the upgrade of our client coverage program, improved client service results, and strengthened pricing discipline are having an impact.

    Despite an uncertain revenue environment, we saw sequential fee revenue growth in FX trading services in our Global Markets business and strong NII. Our strong performance under the 2019 CCAR stress test allowed us to increase our quarterly dividend by 11% from 2Q19 and boost our total capital return to shareholders.

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  • While our pre-tax margin and return on equity fell short of medium-term targets, we remain committed to our 2019 expense program and the expected realization of $400 million in savings by year end and are laser-focused on improving our financial performance by implementing additional ways to reignite revenue growth and generate additional expense reductions going forward.”

    Investment Servicing AUC/A as of quarter-end decreased 3% primarily due to a previously announced client transition, partially offset by higher end of period fixed income market levels. Investment Management AUM as of quarter-end increased 5% due to higher end of period market levels and net inflows of $59 billion, driven by institutional, cash and ETF inflows.

    Investment Servicing mandates announced in 3Q19 totaled $1.0 trillion with quarter-end servicing assets remaining to be installed in future periods of $1.2 trillion. Investment Management net inflows in 3Q19 of $13 billion driven by cash and ETF inflows.

    Fee revenue decreased 3% reflecting lower servicing and management revenues, partially offset by CRD: Compared to 2Q19, fee revenue was flat reflecting higher servicing fees up 2%, management fees up 1%, and foreign exchange trading services revenues up 4%, offset by lower processing fees and seasonally lower securities finance revenue.

    On a standalone basis, CRD generated $85 million in 3Q19 fee revenues(b). Net interest income (NII) decreased 4% primarily due to lower long-end rates and MBS premium amortization, as well as mix shift away from non-interest bearing deposits.

    Compared to 2Q19, NII increased 5% primarily driven by episodic market-related benefits, higher client repo activity, and active deposit management, partially offset by lower long-end rates.

    The weekly charts shows the downtrend could be near an end for this stock.

    STT weekly chart

    A Trade for Short Term Bulls

    As with the ownership of any stock, buying STT 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 STT

    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 STT, the November 15 options allow a trader to gain exposure to the stock.

    A November 15 $65 call option can be bought for about $1.20 and the November 15 $67.50 call could be sold for about $0.41. This trade would cost $0.79 to open, or $79 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 $79.

    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 STT the maximum gain is $1.71 ($67.50 – $65= $2.50; $2.50 – $0.79 = $1.71). This represents $171 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $79 to open this trade.

    That is a potential gain of about 116% in STT based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

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