Another Retailer Sets Up a Trading Opportunity
As earnings season winds down, retailers are reporting results. This has created a number of trading opportunities and, as The Street reported,
“Nike Inc. (NYSE: NKE) shares traded sharply lower … after the world’s biggest sports apparel company posted weaker-than-expected third quarter sales in its key North American market and noted that a stronger dollar would clip profits over the near term.
Nike posted earnings for the three months ending in February, its fiscal third quarter, that were three cents ahead of Wall Street forecasts at 68 cents per share, and currency-neutral revenue gain of 11% to $9.6 billion, but disappointed investors with a top-line tally of $3.81 billion in North America, thanks in part to issues with product launch timing.
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Nike’s four quarter and fiscal year 2020 outlooks were solid, forecasting high single-digit sales growth, once currency movements are stripped away, as it continues to win back market share from German rival Adidas AG in its home U.S. market and capitalizes on its hammer-lock on basketball shoe sales, but a stronger U.S. dollar and planned increases in expenditures could erode earnings potential.
“There were some timing impacts related to our NBA business and the launch of certain products year-over-year,” CFO Andy Champion told investors on a [recent] conference call….
“There are always timing impacts in terms of product launches. So yes, nothing in terms of a turn or change in consumer demand.”
“In fact, consumer demand for our apparel in North America is very strong. Frankly to some extent it puts pressure on supply, but that is that’s a great point of pressure to have,” he added. “We’ve got really strong demand for our apparel in North America.”
Some of Nike’s North American weakness was also linked to the February 20 injury to Duke University Basketball star Zion Williamson injured his knee after his Nike shoe collapsed during a nationally televised game Wednesday night in North Carolina.
Williamson’s Nike PG 2.5 shoe appeared to separate from the sole when he planted his left foot near the top of the key and attempted to pivot to his right in the opening seconds of the contest, causing the 6-7 freshman forward, who has dominated college basketball’s headlines this year, a knee injury that kept him out of action for the final weeks of the regular season.
“Our close examination of figures reported by NKE suggest clearly that broad based momentum continues to drive the business,” said Oppenheimer analyst Brian Nagel. “Early in 2019 we identified NKE as a top pick for the year. We very much stick by that call and recommend clients use any “sell on the news” weakness in shares as an incremental buying opportunity.”
This could mark a reversal in the stock which stalled near its all time highs recently.
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 NKE
For NKE, we could sell an April 18 $82 call for about $1.80 and buy an April 18 $84 call for about $0.95. This trade generates a credit of $0.85, 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 $85. The credit received when the trade is opened, $85 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade in NKE is about $115. The risk can be found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($85).
This trade offers a potential return of about 73% 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 NKE is below $82 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 $115 for this trade in NKE.