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Analysts Follow News in This Stock

Analysts Follow News in This Stock

Analysts often adjust ratings and price targets immediately after a company announces its latest financial results. This is a process that makes sense since the quarterly results provide new information analysts should use to update their models.

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  • One company offers an excellent example of the process, as Benzinga reported,

    Ambarella Inc (NASDAQ: AMBA) stock continued to surge … after the camera chip maker posted a second quarter revenue and earnings beat.

    AMBA daily chart

    KeyBanc Capital Markets raised its revenue estimates for Ambarella after the print.

    The Analyst: John Vinh maintained a Sector Weight rating on the stock.

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  • The Thesis: Ambarella’s strong performance was driven in part by recovery in demand for two big Chinese security camera makers, HikVision and Dahua, both of which came under scrutiny by U.S. officials last year, with concerns that restrictions could be placed on companies doing business with them over national security issues involving facial recognition and espionage.

    Inventory building in response to concerns of a ban was a major driver of Ambarella’s strong results, Vinh said in a Thursday note.

    It’s not clear how long that will last, though.

    Still, overall security demand in China should continue for the next few quarters, the analyst said, adding that the company is also seeing share gains elsewhere.

    But the company, which used to be known mostly as a key GoPro Inc (NASDAQ: GPRO) supplier, is also moving into a new business, providing “computer vision” chips for the automotive market, he said.

    “While still early days, auto represents half of the 40 pre-production customers with broad-based applications,” Vinh said.

    Unfortunately, it could take a while.

    “Given the longer design cycle, meaningful Auto CV revenues are expected by 2022-2023, while current auto growth is largely driven by video recorder ramps,” the analyst said.

    KeyBanc raised its full-year 2020 revenue estimate from $206 million to $225 million.

    After the recent price move, the path of least resistance in the stock appears to be up since there is no clear point of resistance on the chart below which uses weekly data for a longer term view of the price action in the stock.

    AMBA weekly chart

    A Trade for Short Term Bulls

    As with the ownership of any stock, buying AMBA 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

    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 AMBA

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

    A November 15 $65 call option can be bought for about $3.30 and the November 15 $70 call could be sold for about $1.70. 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 AMBA the maximum gain is $3.40 ($70 – $65= $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 $160 to open this trade.

    That is a potential gain of about 88% 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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