Contact Tracing Could Make Twilio an Internet Giant
Trade summary: A bull call spread in Twilio Inc. (NYSE: TWLO) using the June $210 call option which can be bought for about $12.10 and the June $220 call could be sold for about $8.18. This trade would cost $3.92 to open, or $392 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 $3.92. The maximum gain is $608 per contract. That is a potential gain of about 55% based on the amount risked in the trade.
Now, let’s look at the details.
New York City is the hotspot of the Covid pandemic. The city accounts for more than 20% of all cases in the country.
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The city’s recovery efforts will be closely watched by others and that could make the city’s choice of service providers significant. While there is no joy ion profiting from tragedy, there are investment opportunities that traders shouldn’t ignore.
Recently, TWLO made the news when the company announced that it would be part of New York City’s Covid-19 contact tracing initiative.
Twilio’s platform provides cloud contact center and notification solutions for remote contact tracers to interview patients, notify contacts and send symptom survey reminders, it said in a statement.
The company will work with the city’s Department of Information Technology & Telecommunications.
Contact tracing means tracing the contacts of someone who contracted the coronavirus, so the contacts can know they’re at risk.
“Twilio’s platform is well-suited to support the fundamental communication needs for contact tracing, including connecting securely with Covid-19 patients and known contacts, to help monitor the spread of the virus,” the company said.
“It can call, message or email Covid-19 patients, educate them on the virus, and identify their close contacts through self-reporting. The platform also provides messaging-based alerts … that prompt patients to fill out secure surveys on their symptoms.”
This is the latest bullish news for the stock. TheStreet noted that, “Earlier this month, analysts increased their share-price targets for Twilio following a strong first-quarter earnings report.
Twilio’s revenue soared 57% in the first quarter from a year earlier, and its active user base jumped 23%.
In addition, the company forecasts revenue growth of 33% to 35% for this quarter.”
The stock was moving up on the bullish earnings report, gapping out of a trading range and breaking above important resistance.
The weekly chart highlights the potential risks in the stock which is now overbought. After racing higher, a pullback is possible.
While there are still reasons to expect additional gains in the stock, there are also reasons to expect that risks are elevated. Managing risk with a spread trade could be a strategy that is suitable for many traders considering the stock.
A Specific Trade for TWLO
For TWLO, the June 19 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 June 19 $210 call option can be bought for about $12.10 and the June 19 $220 call could be sold for about $8.18. This trade would cost $3.92 to open, or $392 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 $392.
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 TWLO, the maximum gain is $6.08 ($220- $210 = $10; 10- $3.92 = $6.08). This represents $608 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $392 to open this trade.
That is a potential gain of about 55% 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 TWLO 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 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.