Coronavirus Could Hurt This Workplace Software Leader
Trade summary: A bear call spread in Slack Technologies, Inc. (NYSE: WORK), using April 17 $19 call options for about $2.91 and buy an April 17 $22.50 call for about $1.53. This trade generates a credit of $1.38, 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 $212. The risk can be found by subtracting the difference in the strike prices ($350 or $3.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($138). This trade offers a potential return of about 65% of the amount risked.
Now, let’s look at the details.
Barron’s reported on earnings from Slack and more importantly the company’s guidance for the coming quarters. Traders could be looking at Slack as a possible winner since it allows for conversations among remote workers.
Slack makes collaborative communications tools but recently, “the company reported January quarter results that were nicely ahead of expectations, but offered guidance that disappointed. CEO Stewart Butterfield said in an interview that while the company has seen an uptick in downloads, most of that is for the free versions of the company’s software.
For the January quarter, Slack posted revenue of $181.9 million, up 49% from a year ago and ahead of the Street consensus at $174.1 million. For the April quarter, Slack expects revenue of $185 million to $188 million, up 37% to 39%, a little shy of the previous Street consensus at $188.4 million.
For the January 2021 fiscal year, Slack sees revenue of $842 million to $862 million, up 34% to 37%. The Wall Street consensus had been $854.5 million.
The biggest disappointment appears to have been with the company’s billings forecast. Slack sees full-year billings of $970 million to $1 billion, up 27%-31%, which is down from 48% growth in the January 2020 fiscal year. Most analysts had expected a higher range.
Slack has had a wild ride in the public market.” This can be seen in the chart below which shows the trading in WORK since the stock began trading last summer.
Analysts noted that a concern “is that the company’s increasing reliance on enterprise deals means the virus-related restrictions on travel and meetings will have an impact on the business.
William Blair analyst Bhuvan Suri, who has an Outperform rating on Slack shares, notes that “forecasting new deal close rates is particularly difficult in this environment with a pause on nonessential travel and customers potentially pushing purchasing decisions.
He adds that “Slack has become much more weighted to the enterprise over the past few years, and with sales reps out of the field, closing deals can be particularly challenging. In our opinion, taking a conservative view on guidance is the appropriate course at this point.”
Wedbush analyst Dan Ives, who has an Underperform rating and $14 target on Slack, said that the shocker was the billings guidance. He said that the “bullish Street whisper expectations” were for 35% growth.
“We continue to believe the biggest culprit for the softer billings outlook is Microsoft and its Teams initiative competitively speaking, along with an uncertain macro environment looking ahead,” Ives wrote.
MKM Partners analyst Rohit Kulkarni is still bullish on the stock, keeping his Buy rating and $27 target. He thinks the selloff has been driven by two related issues. One, he thinks the company’s guidance increasingly looks back-end loaded, which adds risk. And two, he says management hinted at potential delays in closing enterprise deals.
That said, he also noted the “very healthy uptick in free user signups,” and added that “Slack plays very well along the growing theme of ‘work from home,’ and could drive more experimental usage in enterprises.”
Recent price action pushed the stock below support and sets up a trading opportunity.
A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.
A Specific Trade for WORK
For WORK, we could sell an April 17 $19 call for about $2.91 and buy an April 17 $22.50 call for about $1.53. This trade generates a credit of $1.38, 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 $138. The credit received when the trade is opened, $138 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $212. The risk can be found by subtracting the difference in the strike prices ($350 or $3.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($138).
This trade offers a potential return of about 65% 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 WORK is below $19 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 $212 for this trade in WORK.
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.