Bad News Can Come Ahead of Earnings and Create Opportunities
News can come at expected times, like with earnings reports, or at unexpected times as this news shows. Benzinga recently reported,
“World Wrestling Entertainment, Inc.’s (NYSE: WWE) stock crashed more than 20% [recently] after the company dismissed two long-time executives and cut its 2019 earnings guidance ahead of its fourth-quarter report due out on Feb. 6.”
The news continued, “WWE announced Co-Presidents George Barrios and Michelle Wilson are leaving the company effective immediately. In addition, WWE said it expects to report $180 million in full-year adjusted OIBDA, the low end of its guidance range of $180 million to $190 million.
Analysts had been anticipating $186.6 million.
In a statement, WWE CEO Vince McMahon thanked Wilson and Barrios for their 10-plus years of contributions.
“I am grateful for all that was accomplished during their tenure, but the Board and I decided a change was necessary as we have different views on how best to achieve our strategic priorities moving forward,” McMahon said.
Several Wall Street analysts weighed in on WWE stock following the unexpected executive departures and the guidance cut.
Rosenblatt Securities analyst Bernie McTernan said the huge sell-off is an indication that investors are concerned WWE is on the brink of another large investment cycle. McTernan said required investment levels are the most likely cause for disagreement between management and the board. Without more clarity from the company about the path forward, it’s difficult to determine at this point whether or not the sell-off is a buying opportunity.
“Absent a dilutive deal on the way, we believe the company should send a signal to the market by actively buying back stock at these levels,” McTernan wrote in a note.
Rosenblatt has a Neutral rating and $77 price target for WWE stock.
Needham analyst Laura Martin said Barrios and Wilson served an important role at WWE over the past decade.
“We believe that much of the economic value creation by WWE over the past few years can be credited to the collaboration between visionary founder Vince McMahon with data and ROI disciplines imposed by professional managers Barrios and Wilson,” Martin wrote.
Needham has a Buy rating and $88 price target for WWE stock.
Several other Wall Street firms adjusted their ratings for WWE following the news:
Morgan Stanley cut its rating to Equal-Weight, and set a $54 price target
Evercore ISI cut its rating to In-Line and set a $50 target.
Loop Capital cut its rating to Hold and set a $50 target.
The news pushed the stock price through support that is visible on the longer term chart using weekly data.
A Trading Strategy to Benefit From Potential Weakness
The prospects of a further short-term gains in WWE seem to be remote. But, significant weakness is also unlikely. Traders should consider using an options strategy known as a bear put spread to benefit from the expected trading range in the stock.
This strategy can be profitable when a trader is looking for a steady or declining stock price during the term of the options. The risks and potential rewards of this strategy are illustrated in the payoff diagram shown below.
Source: The Options Industry Council
A bear put spread consists of buying one put and selling another put at a lower exercise price to offset part of the initial cost of the trade. This trading strategy generally profits if the stock price moves lower. The potential profit is limited, but so is the risk should the stock unexpectedly rally.
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.
The Trade Specifics For WWE
The bearish outlook for WWE, at least for the purposes of this trade, is a short-term opinion. To benefit from this outlook, traders can buy put options.
A put option gives the trader the right, but not the obligation, to sell shares at a specified price until the option expire. While buying a put is possible, it can also be expensive. The risk of loss when buying an option is equal to 100% of the amount paid for the option.
To limit the risks, a second put can be sold. This will generate income that can offset the purchase price, potentially allowing a trader to buy a put with a higher exercise price. That increases the probability of success for the trade.
Specifically, the February 21 $50 put can be bought for about $3.60 and the February 21 $45 put can be sold for about $1.40. This trade will cost about $2.20 to enter, or $220 since each contract covers 100 shares, ignoring the cost of commissions which should be small when using a deep discount broker.
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 $220. This loss would be experienced if WWE is above $50 when the options expire. In that case, both options would expire worthless.
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 WWE, the maximum gain is $2.80 ($50 – $45 = $5; $5 – $2.20 = $2.80). This represents $280 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $220 to open this trade.
That is a potential gain of about 127% of the amount risked in the trade. This trade delivers the maximum gain if WWE closes below $45 on February 21 when the options expire.
Put 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 $220 for this trade in WWE.