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Bad News Spells Possible Big Gains in This Stock

Bad News Spells Possible Big Gains in This Stock

Trade summary: A bull call spread in WNS (Holdings) Limited (NYSE: WNS) using the August $60 call option which can be bought for about $4.75 and the August $65 call could be sold for about $1.72. This trade would cost $3.03 to open, or $303 since each contract covers 100 shares of stock.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $303. The maximum gain is $197 per contract. That is a potential gain of about 65% based on the amount risked in the trade.

Now, let’s look at the details.

WNS is a global provider of business process management (BPM) services. The company offers data, voice, analytical and business transformation services. Its operating segments include travel, insurance, banking and financial services, healthcare, utilities, retail and consumer products groups, auto claims and others.

In a recent earnings report, the company noted that revenue and earnings were down. As Business Wire reported, “Revenue in the first quarter was $207.8 million, representing a 3.1% decrease versus Q1 of last year and a 16.3% decrease from the previous quarter. Revenue less repair payments* in the first quarter was $201.4 million, a decrease of 4.8% year-over-year and 14.6% sequentially.

Profit in the fiscal first quarter was $14.8 million, as compared to $27.6 million in Q1 of last year and $29.5 million in the previous quarter. Year-over-year, profit reductions were driven by lower revenue resulting from demand and service delivery impacts associated with the COVID-19 pandemic, increased business continuity costs, higher share-based compensation expense, and a higher effective tax rate.

These headwinds were partially offset by favorable currency movements net of hedging and reductions in travel, facility-related, and discretionary expenditures.

“As expected, the COVID-19 pandemic had a material adverse impact on our fiscal first quarter financial performance. Revenue headwinds in Q1 were driven by volume reductions across several key verticals, and by service delivery constraints resulting from global facility lockdowns,” said Keshav Murugesh, WNS’s Chief Executive Officer.

“During Q1, WNS made tremendous progress in transitioning our delivery to a work-from-home model and providing business continuity to our clients. Today, WNS is delivering 95% of our clients’ requirements, primarily from our employees’ homes.

In addition, we are beginning to see clients willing to discuss, and in some cases move forward with, new BPM opportunities despite the challenging and uncertain business environment. WNS remains focused on ensuring the health and safety of our more than 43,000 global employees and on securely servicing the needs of our clients.

While we understand that our financial performance in fiscal 2021 will be impacted by the COVID-19 pandemic, our goal is to manage what is within our control, continue to invest and innovate, and remain focused on the long-term BPM opportunity. We believe that over the next few years, this pandemic may have potential to drive acceleration in the adoption of BPM services.”

The stock gapped up on the news.

WNS daily chart

The weekly chart shows that the recent consolidation came near long standing support.

A Specific Trade for WNS

 For WNS, the August options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.

An August $60 call option can be bought for about $4.75 and the August $65 call could be sold for about $1.72. This trade would cost $3.03 to open, or $303 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 $303.

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 WNS, the maximum gain is $197 ($65- $60= $5; 5- $3.03 = $1.97). This represents $197 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $303 to open this trade.

That is a potential gain of about 65% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

A Trade for Short Term Bulls

As with the ownership of any stock, buying WNS 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  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 Council

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.