Cerence Is Positioned to Provide a 163% Gain
Trade summary: A bull call spread in Cerence Inc. (Nasdaq: CRNC) using the December $85 call option which can be bought for about $5.40 and the December $90 call could be sold for about $3.50. This trade would cost $1.90 to open, or $190 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 $190. The maximum gain is $310 per contract. That is a potential gain of about 163% based on the amount risked in the trade.
Now, let’s look at the details.
A news release on Globe Newswire noted,
CRNC reported its fourth quarter and fiscal year 2020 results for the year ended September 30, 2020.
Sanjay Dhawan, Chief Executive Officer of Cerence, stated, “Our Q4 financial performance exceeded our expectations for every metric and delivered record revenue, record gross margin and record EBITDA. Cerence’s first year as a stand-alone business established the company as a major player in conversational AI for the car.
We had to separate the business from Nuance and deal with the economic impact of Covid-19, but we did so while at the same time continuing a relentless introduction of new products and upgraded technologies. We’re more agile and more aggressive in our approach to innovation and more dedicated to the success of our customers than ever.
I’m especially proud of the recognition that the Cerence team has received from our customers regarding our support in helping them achieve their start of production dates without delay.”
Dhawan continued, “Further demonstrating the depth of our customer relationships, we recently signed a renewal agreement for our SaaS-based connected services with a major global automaker, marking the successful renewal of an expiring contract since Cerence became a standalone public company.
This contract extension is an important endorsement from a long-time, respected partner on the strength and value of Cerence Connected Services and ensures that we will continue providing cloud-based services for this popular app suite for drivers.”
“As we start the new fiscal year, we are expecting another year of growth supported by a strong backlog and a solid pipeline of new business opportunities. The company’s competitive position remains strong as we rely on innovation and speed of execution to continue to drive our business forward,” Dhawan concluded.”
The stock was up and the earnings announcement could be the catalyst for the gain.
However, the weekly chart shows that the stock is extended, more than 10% above the breakout from recent consolidation.
The extended run makes risk a primary consideration in trading the stock.
A Specific Trade for CRNC
For CRNC, the December options allow a trader to gain exposure to the stock. This trade will be open for about three weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A December $85 call option can be bought for about $5.40 and the December $90 call could be sold for about $3.50. This trade would cost $1.90 to open, or $190 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 $190.
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 CRNC, the maximum gain is $310 ($90- $85= $5; 5- $1.90 = $3.10). This represents $310 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $190 to open this trade.
That is a potential gain of about 163% 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 CRNC 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.