Asset Sales Can Be a Sign of Trouble
Companies sometimes sell off assets. It is often done to help management focus on a desired outcome or to increase the company’s cash balance to ensure it maintains the ability to continue operating as a business. Traders are often forced to assess the reason behind the sale.
In most sales, the unit that is disposed of can be underperforming. That is a common reason to sell an asset. Or, it might just be too different from the company’s core business. In rare cases, a company sells a prize asset to continue operating which is a strategy Sears seemed to employ for years.
The reason for a sale by ConAgra Brands Inc. (NYSE: CAG) is less apparent.
Earnings and News Scare Traders
In a recent article in the Chicago Business Journal, ConAgra said it has sold its Wesson Oil brand to a Canadian agribusiness.
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The company also reported its second quarter earnings, and shares tumbled nearly 17 percent as traders assessed all of the news from the company.
ConAgra didn’t reveal the Wesson Oil sale price to Richardson International. But, earlier this year, ConAgra tried to sell Wesson Oil for $285 million to The J.M. Smucker Company until the Federal Trade Commission voiced objections to the deal in March, and the companies scuttled the deal.
Earnings that were announced missed analysts’ revenue expectations and ConAgra CEO Sean Connelly explained that the company’s $8.2 billion purchase of Pinnacle Foods Inc. completed in late October hasn’t gone without problems.
“In the short time since completing the Pinnacle acquisition, our team has been working hard on a seamless integration and an intense diagnostic to clarify both the challenges and opportunities within the Pinnacle portfolio.
While we have identified challenges, they are clearly executional, not structural, in nature. We are aggressively applying Conagra’s proven brand-building and innovation playbook to restore share growth,” Connelly said in a statement.
Connelly was more blunt in a conference call with investors that the Pinnacle purchase hasn’t gone as well as expected.
“The results clearly show the innovation was insufficient to sustain growth, primarily because it was subpar in its execution,” he said.
“Each brand has lost shared with competition. Given these dynamics, the Pinnacle business will unfortunately under-deliver its pretty close internal standalone targets. … These results are highly disappointing.”
The company acknowledged it was also having sales woes in its frozen-food section.
“The decline in refrigerated reflects the fact that with the exception of Reddi-wip, we have yet to bring innovation to the marketplace,” Connelly said in the conference call.
In the latest quarter, ConAgra said revenues rose 9.7 percent to $2.38 billion, missing analysts’ expectations of $2.41 billion.
Traders were clearly disappointed by the news.
The stock is now in a clear down trend after the news pushed the price below important support.
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.
A Bear Call Spread in CAG
For CAG, we could sell a January 18 $23 call for about $0.63 and buy a January 18 $25 call for about $0.20. This trade generates a credit of $0.43, 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 $43. The credit received when the trade is opened, $43 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $157. 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 ($43).
This trade offers a potential return of about 27% 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 CAG is below $23 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 $157 for this trade in CAG.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.