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An EV Trade With Low Risk

An EV Trade With Low Risk

Trade summary: A bull call spread in Workhorse Group Inc. (Nasdaq: WKHS) using the October $23 call option which can be bought for about $5 and the October $28 call could be sold for about $3.35. This trade would cost $1.65 to open, or $165 since each contract covers 100 shares of stock.

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  • In this trade, the maximum loss would be equal to the amount spent to open the trade, or $165. The maximum gain is $335 per contract. That is a potential gain of about 103% based on the amount risked in the trade.

    Now, let’s look at the details.

    Barron’s recently noted that “Commercial electric-van maker Workhorse Group has a new Buy rating from Oppenheimer analyst Colin Rusch. He calls the company a leader in last-mile delivery solutions and established a new $23 price target for shares, up about 25% from recent levels.

    Now four of five analysts covering WKHS rate shares a Buy. The average Buy-rating ratio for stock in the Dow Jones Industrial Average is about 55%. What’s more, the Buy-rating ratio for Tesla stock (TSLA) is 16%. Two out of five analysts covering electric heavy-duty-truck maker Nikola (NKLA) rate its shares Buy.

    Workhorse is becoming Wall Street’s favorite EV stock.

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  • Workhorse doesn’t directly compete with either Nikola or Tesla. It’s all about delivery vans. The company just started delivering its C-series electric delivery vans to customers, but Workhorse has been working on the vehicles for years.

    “With 5 [million] miles driven, Workhorse is far and away the leading platform from a miles-driven perspective for last-mile EVs,” wrote Rusch in his report. “We believe their vehicles serve an [$18 billion] U.S. market in which consumers are not willing to compromise on service.”

    Electric vehicles make a lot of sense in commercial applications with a lot of stop/start driving and when vehicles can be recharged in a central location at night. What’s more, when commercial vehicles are driven more than personal cars, the energy savings pile up more quickly. Electricity to charge the batteries typically costs less than the equivalent amount of gasoline.

    In additional to EV adoption by commercial fleet operators, Rusch identified several catalysts that could help the stock over the near term. Workhorse is bidding on U.S. Postal Service business to replace some of its vehicles—those white, right-hand drive mail-delivery trucks. The company also owns a stake in Lordstown Motor, which will be publicly traded by merging with a special-purpose acquisition company, DiamondPeak (DPHC). Lordstown is launching a light-duty pickup truck called Endurance.

    The SPAC transaction might unlock some value—Workhorse owns 10% of Lordstown. It will, at least, provide liquidity.”

    WKHS is now in a consolidation pattern.

    WKHS daily chart

    A breakout could lead to a significant gain in the stock.

    A Specific Trade for WKHS

     For WKHS, the October 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.

    An October $23 call option can be bought for about $5 and the October $28 call could be sold for about $3.35. This trade would cost $1.65 to open, or $165 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 $165.

    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 WKHS, the maximum gain is $335 ($28- $23= $5; 5- $1.65 = $3.35). This represents $335 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $165 to open this trade.

    That is a potential gain of about 103% 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 WKHS 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 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 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.

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