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Brokers Can Find Great Trades

Brokers Can Find Great Trades

Source: Weight Watchers.com

In 2018, many individual investors use deep discount brokers. Some have forgotten about the benefits the more expensive full service brokers provide. Other individual investors have never used anything except an online deep discount broker and might never think full service brokers can add value.

Full service brokers do charge higher commissions. But, they can provide benefits including detailed research. Much of their research is intended for professional investment managers but they often shared the reports with individual investors.

Professional managers at even small funds can generate significant commissions, especially since the commissions are passed onto clients. To compete for those commissions full service brokers are likely to continue generating research reports and those reports can still benefit individual investors.

The benefit can result from the report being released to financial reports. That’s what happened with Weight Watchers International, Inc. (NYSE: WTW).

Not all research reports will lead to a sharp market move either up or down. And, there’s no way to forecast which ones will spark a large move. But, traders can almost always profit from reacting to news.

J.P. Morgan Sparks a Rally

Shares of WTW jumped after analysts at J.P. Morgan wrote that it was time to “stop watching from the sidelines.”

WTW daily chart

According to MarketWatch, “Analysts started coverage of the stock with an overweight rating and price target of $105, which is 14% above current levels.”

“Following three years of double-digit revenue and earnings pressure through 2015, management stabilized the trajectory, repositioning the company for outsized growth by revamping its points program, significantly improving the mobile platform, and recruiting pivotal social media influencers.”

In 2015, the company announced that Oprah Winfrey bought a 10% equity stake. That seemed to be a catalyst for the stock.

WTW weekly chartJ.P. Morgan believes the gains can continue.

The research note concluded that, “Although the stock has already performed “extremely well” this year–it’s up 108% year to date while the S&P 500 has gained 4.2%–J.P. Morgan still sees more upside driven by positive earnings revisions and multiple expansion, “as investors gain comfort around the sustainability of [WTW’s] growth story.”

However, the big run up is a reason for caution and individual investors should consider the potential risks of the stock in addition to the potential rewards. The risks are that a pull back could give way to strong decline if profit taking sets in.

A Trade for Short Term Bulls

As with the ownership of any stock, buying WTW 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 has 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 prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for WTW

For WTW, the July 13 options allow a trader to gain exposure to the stock.

A July 13 $93 call option can be bought for about $1 and the July 13 $95 call could be sold for about $0.70. This trade would cost $0.30 to open, or $30 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 $30.

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 WTW the maximum gain is $1.70 ($95 – $93 = $2.00; $2.00 – $0.30 = $1.70). This represents $170 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $30 to open this trade.

That is a potential gain of about 460% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.