Beyond Meat’s Selloff Creates Potential Income of 66%
Trade summary: A bear call spread in Beyond Meat, Inc. (Nasdaq: BYND) using December $120 call options for about $11.00 and buy a December $125 call for about $9. This trade generates a credit of $2.00, which is the difference in the amount of premium for the call that is sold and the call.
In this trade, the maximum risk is about $300. 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 ($200). This trade offers a potential return of about 66% of the amount risked.
Now, let’s look at the details.
Barclays analyst Benjamin Theurer reiterated an Underweight rating on Beyond Meat (Nasdaq: BYND) stock [recently], and lowered his price target to $100 from $115, on the heels of the company’s third-quarter results.
The disappointing quarter led Theurer to trim his sales forecasts for this fiscal year and next, as the company faces tough comparisons and ongoing pressure on its restaurant business.
Theurer writes that the near-term outlook for Beyond Meat looks uncertain, and wasn’t helped by “confusing commentary” from McDonald’s (MCD) vis-à-vis the latter’s launch of McPlant. (Beyond Meat stock fell after McDonald’s made the announcement, although Beyond Meat later said it had partnered with the fast-food giant to develop the plant-based burger patties.)
That commentary, paired with the downbeat report, means “investors will require assurance by all parties involved” to the extent of any potential partnership.
He also thinks that the post-earnings selloff reflects investor concern about how the stock can regain momentum in the near future after revenue missed the mark.
Indeed, Theurer notes that retail sales in the third quarter were down about 30%, below his estimates and the prior quarter’s levels, likely reflecting consumers stockpiling products earlier in the year. His research leads him to believe that Beyond Meat’s gains in U.S. households stalled out in August, and the company has since lost relative share to Kellogg’s (K) Morningstar Farms brand and privately held Impossible Foods. Other analysts have also pointed to increased share for competitors.
That said, he notes that Beyond Meat’s bulk offerings have increased the average amount consumers spend on its products, and repeat-purchase rates have begun to recover from a dip over the summer.”
BYND has been volatile since it began trading last year and the latest decline is testing support. A break could send the stock to new lows, with a price target of about $50 although selling is likely to accelerate and a lower price is possible.
A Specific Trade for BYND
For BYND, we could sell a December $120 call for about $11 and buy a December $125 call for about $9. This trade generates a credit of $2.00, 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 $200. The credit received when the trade is opened, $200 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $300. 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 ($200).
This trade offers a potential return of about 66% 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 BYND 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 $300 for this trade in BYND.
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.