An IPO That Hasn’t Stumbled
IPOs, or initial public offerings, have been in the news recently, often for reasons related to the fact that the stock failed to meet expectations. But not all IPOs are disappointments. As Barrons recently reported,
PagerDuty (NYSE: PD), a provider of digital operations management software, came out with its first earnings report since it went public on April 10 at $24 a share.
After the news, PagerDuty shares were up and trading at some times at a level that was more than double the initial public offering price.
For its fiscal first quarter, ended April 30, PagerDuty posted revenue of $37.3 million, up 49% year over year, and ahead of the Street consensus at $35 million. The company posted a non-GAAP loss of 22 cents a share, in line with estimates.
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The company expects revenue of $38.5 million to $39.5 million in its fiscal second quarter, with a loss of 9 cents to 10 cents a share. Wall Street had been expecting forecast of $37.1 million of revenue and a loss of 10 cents.
For the January 2020 fiscal year, PagerDuty sees revenue of $161 million to $163 million, ahead of the recent Street consensus at $155.8 million. The company expects a loss for the full year on 37-38 cents a share, on a non-GAAP basis.
In an interview with Barron’s Thursday afternoon, CEO Jennifer Tejada explained that the company’s focus is on digitizing incident- management systems, using machine learning and AI techniques to identify technology issues before they get picked by human users. She says PagerDuty estimates the size of the incident-management market at $25 billion, a figure that gives the company enormous headroom for continued growth.
PagerDuty’s software works with more than 300 software platforms to find potential issues before they can damage business, Tejada said.
“We continued to see growing demand across industry verticals and customer segments, especially the enterprise segment,” she said in a statement.
“Our existing customers are expanding their use of PagerDuty, adding teams and adopting new products like Event Intelligence and Analytics that enable a more proactive approach to digital operations. With our community applying PagerDuty to new use cases every day, we are just scratching the surface of the potential for our business.”
The weekly chart highlights the volatile nature of the stock and demonstrates the value of risk management strategies.
A Trade for Short Term Bulls
As with the ownership of any stock, buying PD 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.
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 PD
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 PD, the July 19 options allow a trader to gain exposure to the stock.
A July 19 $60 call option can be bought for about $3.50 and the July 19 $65 call could be sold for about $1.90. This trade would cost $1.60 to open, or $160 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 $160.
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 PD the maximum gain is $3.40 ($65 – $60= $5; $5 – $1.60 = $3.40). This represents $340 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $86 to open this trade.
That is a potential gain of about 112% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.