Contactless Payments Could Drive a 159% Gain for PayPal Traders
Trade summary: A bull call spread in PayPal Holdings, Inc. (Nasdaq: PYPL) using the June 17 $150 call option which can be bought for about $5 and the June 17 $155 call could be sold for about $3.61. This trade would cost $1.39 to open, or $139 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 $1.39. The maximum gain is $361 per contract. That is a potential gain of about 159% based on the amount risked in the trade.
Now, let’s look at the details.
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And for digital payments giant PayPal, that new reality is one of the primary reasons why its stock is now hovering around a record high while the global economy has fallen off a cliff due to the health crisis.
“I do think that COVID-19 has fundamentally changed some consumer behaviors, which I think certainly play to our benefit. As we look at the environment right now — and for all the real personal and economic concerns around coronavirus — our platform is more relevant than ever before,” PayPal CFO John Rainey said.”
PayPal’s CEO was commenting about the company’s most recent earnings report.
In The Street, details of the report show the bullish potential for the stock,
[PYPL] said things started looking up in April and that on May 1 it enjoyed the highest volume transaction day in its history.
As for the earnings, net income totaled $84 million, or 7 cents a share, in the first quarter, down from $667 million, or 56 cents a share, a year ago. Analysts polled by FactSet predicted the latest EPS would tally 38 cents.
Among other special items, the latest EPS includes a 17-cent subtraction from a credit reserve the company is taking in response to economic weakness.
Adjusted EPS registered 66 cents in the latest quarter, unchanged from a year earlier. Analysts forecast 75 cents for the latest quarter.
Revenue came in at $4.62 billion for the first quarter, up 12% from $4.13 billion a year ago. Analysts estimated the latest figure would be $4.74 billion.
The company prefers to focus on the positive, of course. “As our platform sees record increases in both new customer accounts and transactions, it is clear that PayPal’s products are more important and relevant than ever before,” CEO Dan Schulman said in a statement.
“The strength of our customer value proposition combined with the acceleration of digital payments adoption significantly accelerated in April, with increased demand and engagement.”
The stock price was up on the news.
The weekly chart highlights the extended trading range and potential of the stock.
The pattern points to a price target between $140 and $160, depending on how aggressive an analyst is in defining the upside potential. At $140, there is still significant potential with leverage.
A Specific Trade for PYPL
For PYPL, 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 $150 call option can be bought for about $5 and the June 19 $155 call could be sold for about $3.61. This trade would cost $1.39 to open, or $139 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 $139.
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 PYPL, the maximum gain is $3.61 ($155- $150= $5; 5- $1.39 = $3.61). This represents $361 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $139 to open this trade.
That is a potential gain of about 159% 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 PYPL 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.