Beyond Meat’s Struggles Offer Income Potential of 61%
Trade summary: A bear call spread in Beyond Meat, Inc. (Nasdaq: BYND) using March 20 $85 call options for about $8.78 and buy a March 20 $90 call for about $6.87. This trade generates a credit of $191, 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 $309. 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 ($191). This trade offers a potential return of about 61% of the amount risked.
Now, let’s look at the details.
“Beyond Meat crushed Wall Street estimates when reporting fourth-quarter numbers [recently]. The stock dropped anyway.
Wall Street is weighing in and the big disappointment appears to be all about profit margins.
“Gross [profit] margin of 34.0% was in line with consensus, however, this represented a sequential decline from last quarter’s gross margin of 35.6%,” wrote Bernstein analyst Alexia Howard.
manufacturing of its vegetable-based protein Profit-margin pressure was due to the timing of capacity expansions at two of Beyond Meat’s co-manufacturers, as the company outsources the products.
Still, the sales performance by the company was impressive. “We believe that the top-line guidance could be conservative as the company only included confirmed contracts in its forecast while excluding potential opportunities,” added Howard.
Those opportunities include more business with restaurant chains such as Yum Brands ’ (YUM) KFC and McDonald’s (MCD). The Golden Arches is currently testing a plant-based burger in Canada.
Howard, in sum, is neutral on Beyond Meat. She rates shares at the equivalent to Hold and has a $119 price target. …
Others analysts are more cautious. Strong sales weren’t enough for Wells Fargo analyst John Baumgartner to raise his below-market price target. He rates Beyond Meat stock at the equivalent of Hold and has a $72 target price. Baumgartner believes Beyond Meat’s gross-margin guidance disappointed the Street.
Beyond Meat expects to generate 33% to 35% gross-profit margins in 2020. Analysts had modeled about 35%. Baumgartner noted in a Friday research report that reinvestment is weighing on the company’s 2020 earnings before interest, taxes, depreciation, and amortization (Ebitda).
Beyond Meat is growing rapidly and spending money up front to sell more product down the road. Capital spending in 2020 is expected to reach $40 million, up from about $24 million in 2019.
How high margins can go at Beyond Meat is a debate on Wall Street. Margins will rise as the company matures, but alternative-meat prices need to come down to stimulate more demand.
Beyond Meat Chief Financial Officer Mark Nelson said on [a recent] conference call that the company sees efficiencies from higher volumes, and will pass on cost savings to the consumer “as we pursue our goal to achieve price parity with animal protein in at least in one of our product categories by 2024.”
The stock’s “bumpy road” is another reason for caution, according to Baumgartner. Beyond Meat stock is very volatile, ranging from $25—at the initial public offering in May—to nearly 10 times that only a few months later.
Analysts believe the company could earn $1.25 in 2022. That makes the current price potentially expensive, especially in a weak market.
A Specific Trade for BYND
For BYND, we could sell a March 20 $85 call for about $8.78 and buy a March 20 $90 call for about $6.87. This trade generates a credit of $1.91, 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 $191. The credit received when the trade is opened, $191 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $309. 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 ($181).
This trade offers a potential return of about 61% 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 $85 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 $309 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.