Bad News Could Spell Big Gains for Traders In This Stock
There are times when it seems as if traders need to struggle to see the bad news. For example, it might not seem bad that a company reported sales growth of 67%. That’s especially true if the sales beast analysts’ expectations. But there can be bad news, even when growth sounds strong. Benzinga recently reported that “Mongodb Inc (Nasdaq: MDB) shares sank more than 9% after the company reported a mixed second quarter [recently].”
The chart below shows the stock subsequently found some support near the lows of that decline.
MongoDB’s adjusted EPS in the quarter was a loss of 26 cents, missing consensus estimates by 2 cents. Revenue for the quarter was $99.37, beating analyst expectations by $7.67 million.
MongoDB said subscription revenue was up 71% and services revenue was up 15% compared to a year ago. The company guided for a third-quarter non-GAAP EPS loss of between 27 cents and 29 cents and third-quarter revenue of between $98 million and $100 million.
Several analysts have weighed in on MongoDB since the report. Here’s a sampling of what they had to say.
JMP Securities analyst Patrick Walravens said the weakness is due to revenue growth deceleration from 78% in the first quarter to just 67% in the second quarter.
“The biggest positive in this remarkable story is MongoDB Atlas, the cloud-hosted offering that was started three years ago, now represents ~$150M in revenue and grew a staggering 243% year over year, while the area investors are likely to have questions about it the big deceleration in the Q3 revenue guidance,” Walravens wrote in a note.
He attributes the third-quarter slowdown to a conservative forecast, tougher comps and the timing of customer transitions from mLab to Atlas.
Short Squeeze Potential
Barclays analyst Raimo Lenschow said solid second-quarter numbers and conservative guidance have MongoDG shares set up for a short squeeze.
“Eventually this will create a short squeeze, which should help shares,” Lenschow wrote.
Leschow said the rise of Atlas is creating a more positive revenue mix effect that should help boost growth in coming years.
The bad news in MDB comes after a sustained and significant rally in the stock price. The recent highs could prove to be resistance as investors who have triple digit gains lock in their profits.
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 MDB
For MDB, we could sell an October 18 $120 call for about $9.15 and buy an October 18 $125 call for about $8. This trade generates a credit of $1.15, 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 $115. The credit received when the trade is opened, $115 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $385. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($115).
This trade offers a potential return of about 29% 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 MDB is below $120 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 $385 for this trade in MDB.