Barbie Powers Mattel and Sets Up a Potential Triple Digit Gain
Trade summary: A bull call spread in Mattel, Inc. (Nasdaq: MAT) using the December $14 call option which can be bought for about $1.10 and the December $16 call could be sold for about $0.40. This trade would cost $0.70 to open, or $70 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 $70. The maximum gain is $130 per contract. That is a potential gain of about 185% based on the amount risked in the trade.
Now, let’s look at the details.
Bloomberg reported that MAT rose “after third-quarter results shattered expectations, lifted by consumers snapping up Barbie dolls and Hot Wheels toys during the pandemic.
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The company’s doll sales surged 22% compared with a year earlier, as families looked for cheap ways to entertain lockdown-bored children.
Revenue rose 10% to $1.63 billion in the period, Mattel said [recently], topping analysts’ predictions of $1.46 billion. Adjusted profit was 95 cents a share, beating estimates of 39 cents, as the company continued to work on cutting costs.
Mattel has addressed inventory problems posed by the coronavirus and expects a stronger-than-normal holiday buying season, Chief Executive Officer Ynon Kreiz said in an interview. The company said that inventories at retail outlets were lower than at the same time last year, and they’re working together to avoid product shortages.
Besides the impact of parents assuaging restless kids, the lack of new movie franchises tied to competing toy brands may provide a further boost to Mattel. The company relies on time-honored products such as Barbie, Uno and Pictionary.
Shares of rival Hasbro Inc. also got a boost from the results, climbing as much as 2.5% Friday.
What Bloomberg Intelligence Says:
“Mattel’s longer-dated bonds, rated B3/B-, could tighten as the company delevers faster with a strong holiday toy season driven by Barbie gains and increased online shopping. Results in 3Q were strong, mainly on Barbie rising 30% year-over-year. Leverage at 4.5x is approaching an inflection point and should decline as Ebitda improves.”
Mattel also said it expects sales in 2020 overall to be roughly flat compared with last year, but its adjusted profit margin should rise to as high as 49%.
The company is looking to get more money from its intellectual-property rights, rather than just relying on product sales. It has 10 films in development but hasn’t set release dates for any of its movies.
Mattel withdrew its 2020 guidance earlier in the year due to uncertainty over the coronavirus, which affected both the production of new products and demand. The company did say in July it expects sales to improve in the second half of the year after they fell 14% year-over-year during the first six months of 2020, and see run-rate cost savings of $1 billion.”
The stock is now well above its 52-week lows but remains off its all-time highs and faces significant resistance as it attempts to rally higher. This creates a relatively high risk of a selloff, despite the good news and relatively positive outlook.
A Specific Trade for MAT
For MAT, the December 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.
A December $14 call option can be bought for about $1.10 and the December $16 call could be sold for about $0.40. This trade would cost $0.70 to open, or $70 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 $70.
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 MAT, the maximum gain is $130 ($16- $14= $2; 2- $0.70 = $1.30). This represents $130 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $70 to open this trade.
That is a potential gain of about 185% 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 MAT 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 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.
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.