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An Earnings Report and an Income Opportunity

An Earnings Report and an Income Opportunity

The story might not be interesting to all traders. Globe Newswire reported,

The Ensign Group, Inc. (Nasdaq: ENSG), the parent company of the Ensign group of skilled nursing, rehabilitative care services, home health, home care, hospice care and senior living companies, today announced its operating results for the second quarter of 2019, reporting a GAAP diluted earnings per share of $0.51 for the quarter with adjusted earnings per share of $0.54 for the quarter.

Highlights of the report include:

  • GAAP earnings per share for the quarter was a record $0.51, an increase of 24.4% over the prior year quarter, and adjusted earnings per share was $0.54, up 22.7% over the prior year quarter.
  • Consolidated GAAP Net Income for the quarter was $28.6 million, an increase of 30.0% over the prior year quarter, and adjusted Net Income was $30.3 million, an increase of 27.8% over the prior year quarter.
  • Same store skilled services occupancy was 80.1%, an increase of 272 basis points over the prior year quarter, and skilled managed care revenue was up 8.5%.
  • Transitioning skilled services occupancy was 78.0%, an increase of 375 basis points over the prior year quarter; and skilled managed care revenue was up 24.3%.
  • Total Transitional and Skilled Services segment revenue was $469.2 million, an increase of 14.9%, and segment income was $56.7 million for the quarter, an increase of 31.1% over the prior year quarter.
  • Total Home Health and Hospice Services segment revenue for the quarter was up 21.7% over the prior year quarter to $50.2 million; segment income was up 16.6% over the prior year quarter to $7.3 million and 6.4% sequentially over the first quarter of 2019.

The stock sold off on the news.

ENSG daily chart

The selling comes after an up-trend and could be the beginning of a trend reversal.

ENSG weekly chart

Rather than looking at this stock, some traders would move on to the next one in search of buy candidates. Others will simply look at the stock as it is and question if there is a trading opportunity based on growth, momentum, value, income or some other strategy.

Taking that latter approach can be rewarding since almost all stocks will have a trading opportunity when viewed with an open mind. For example, in this case, there is a potential high income opportunity.

 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 ENSG

For ENSG, we could sell a September 20 $50 call for about $4.20 and buy a September 20 $55 call for about $1.75. This trade generates a credit of $2.45, 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 $245. The credit received when the trade is opened, $245 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $255. 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 ($245).

This trade offers a potential return of about 96% 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 ENSG 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 $255 for this trade in ENSG.