Dell Offers a Potential 45% Gain to Short Term Traders
Trade summary: A bull call spread in Dell Technologies Inc. (NYSE: DELL) using the June $50 call option which can be bought for about $1.62 and the June $52.50 call could be sold for about $0.60. This trade would cost $1.02 to open, or $102 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 $1.02. The maximum gain is $148 per contract. That is a potential gain of about 45% based on the amount risked in the trade.
Now, let’s look at the details.
A better than expected earnings report sparked a rally in DELL.
The news, according to Barron’s was,
“Dell Technologies posted better-than-expected results for its fiscal first quarter as demand for notebooks heated up as more people switched to working and learning from home. But the strength in PCs was partially offset by weaker demand for enterprise hardware, with most offices shut down.
The results in many ways were consistent with [earlier]s earnings report from HP Inc. which showed strength in the PC business, but softness in printers and related supplies that target enterprise customers.
For the quarter ended May 3, DELL posted revenue of $21.9 billion, flat with a year ago, and well ahead of the Street consensus at $20.8 billion. On a constant currency basis, revenue was up 1.7%. Non-GAAP earnings were $1.34 a share, ahead of the Street consensus at $1.01 a share. While product revenues were down 3%, service revenues rose 10%.
Revenues increased 2% at the company’s Client Solutions Group, while revenue at majority-owned VMware was $2.76 billion, up 12%, and ahead of Street consensus at $2.65 billion.
But revenues fell 8% at the company’s infrastructure solutions group, which provides hardware and software to enterprise customers. Dell said the decline reflects that customers were “directing more spend towards remote work and business continuity solutions.”
Dell reported double-digit unit and revenue growth in commercial notebooks, and high single-digit growth in mobile workstations. Consumer PC revenue growth was down 5%. Storage revenue was down 5%, while servers and networking revenue was down 10%.
In a statement, Dell Chief Operating Officer Jeff Clarke said the company saw orders up 15% to 20% from banking and financial services, government, health-care, and life sciences customers.”
DELL has only been trading for about a year and is below the price seen after the stock began trading. Given that many traders bought the stock as it began trading, traders should expect considerable resistance. That is a risk, but in the short run there could be a significant rally.
A Specific Trade for DELL
For DELL, 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 $50 call option can be bought for about $1.62 and the June 19 $52.50 call could be sold for about $0.60. This trade would cost $1.02 to open, or $102 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 $102.
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 DELL, the maximum gain is $1.48 ($52.50- $50= $2.50; 2.50- $1.02 = $1.48). This represents $148 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $102 to open this trade.
That is a potential gain of about 45% 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 DELL 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.