An Earnings Miss Sets Up a Quick Trade
Genuine Parts (NYSE: GPC) recently came out with quarterly earnings of $1.28 per share, missing the Zacks Consensus Estimate of $1.31 per share. This compares to earnings of $1.27 per share a year ago. These figures are adjusted for non-recurring items.
This quarterly report represents an earnings surprise of -2.29%. A quarter ago, it was expected that this auto and industrial parts distributor would post earnings of $1.32 per share when it actually produced earnings of $1.35, delivering a surprise of 2.27%.
Over the last four quarters, the company has surpassed consensus EPS estimates two times.
As PR Newswire reported,
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“Sales for the first quarter ended March 31, 2019 were $4.7 billion, a 3.3% increase compared to $4.6 billion for the same period in 2018. Total sales for the first quarter included 3.3% comparable growth, approximately 2% from acquisitions, and an approximate 2% negative impact from foreign currency translation.”
Paul Donahue, President and Chief Executive Officer, commented, “We were pleased to produce another quarter of positive sales comps across each of our business segments while also benefiting from the favorable impact of ongoing strategic acquisitions.
Our sales performance was indicative of the continued improvement in our U.S. automotive business and the steady growth we continue to generate in our Australasian and Canadian operations.
Our strength in these areas offset the pressure on our core automotive results in Europe related to mild winter weather and economic considerations. Our industrial business remains strong and we made further progress in stabilizing the Business Products Group.
Overall, we performed in-line with our expectations for the first quarter, despite the headwinds of foreign currency translation and one less selling day and remain confident in the additional growth opportunities we see for GPC.”
Looking ahead, the company is reaffirming its full year 2019 sales and earnings guidance and continues to expect sales to increase 3% to 4%, or up an adjusted 4% to 5% before an expected headwind from currency translation of 1%.
GPC expects diluted earnings per share to range from $5.56 to $5.71 and is reiterating its outlook for adjusted diluted earnings per share of $5.75 to $5.90, adjusted for the impact of the 1% currency headwind. Additionally, the company continues to expect a tax rate of approximately 25% in 2019.
Traders seemed disappointed by the news and selling pressure pushed the stock down.
The longer-term chart shows the magnitude of the decline from all time highs could push the stock back into the lower trading range that contained prices for the past few years.
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.
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 GPC
For GPC, we could sell a May 17 $100 call for about $4.50 and buy a May 17 $105 call for about $1.08. This trade generates a credit of $3.42, 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 $342. The credit received when the trade is opened, $342 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $158. 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 ($342).
This trade offers a potential return of about 116% 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 GPC is below $100 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 $158 for this trade in GPC.