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Disappointing Earnings Create a High-Income Opportunity

Disappointing Earnings Create a High-Income Opportunity

A recent earnings report sent a stock lower, and that could be good news for income investors.  As PR Newswire reported,

“LyondellBasell Industries (NYSE: LYB) recently announced earnings and logged net profits of $1,003 million or $2.70 per share in second-quarter 2019, down from $1,654 million or $4.22 in the year-ago quarter.

Barring one-time items, adjusted earnings came in at $2.75 per share.

LyondellBasell generated revenues of $9,048 million, down roughly 11.3% year over year.

Consolidated EBITDA declined around 21.4% year over year to $1,579 million.

Integration activities related to the acquisition of A. Schulman are on schedule and expected to generate approximately $100 million in forward annual run-rate synergies as of the close of the second quarter.

Despite our Houston refinery operating at 97% of nameplate capacity, low discounts for heavy sour crude oil in the U.S. Gulf Coast market continued to pressure the profitability of our Refining segment,” said Bob Patel, LyondellBasell CEO.”

Traders seemed to be disappointed by the news.

LYB daily chart

LYB is a Houston-based plastics, chemicals and refining company. The company operates through its Advanced Polymer Solutions segment.

It produces olefins and polyethylene (PE) and polypropylene (PP), high density polyethylene (HDPE), low density polyethylene (LDPE) and linear low density polyethylene (LLDPE).

It produces PP homopolymers, PP impact copolymers and PP random copolymers. PP compounds are produced from blends of polyolefins and additives and are sold to the automotive and home appliances industries.

Its engineered composites are lightweight, materials that are used in infrastructure, aerospace and automotive applications such as headlamps. It also manufactures powders, which is a specialty particle materials used in coatings, rotational molding, toll compounding and other technical applications.

Masterbatches is a coloring and additive materials used in the production of paper, paint and plastic goods around the world.

These are all products used in industrial products and industrial processes that result in consumer products.

This is the type of company that could be adversely impacted by an economic slowdown, a trade war, or both. And, traders seem to be weighing the possibility of both possible outcomes.

LYB, and other stocks in basic industries, seem to be weighed down by the news and that is potentially bearish for these companies. The bearishness can be seen in charts that look back, like the longer term chart of LYB using weekly data shown below.

LYB weekly chart

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.

bear call spread

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.

Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

A Bear Call Spread in LYB

For LYB, we could sell a September 20 $75 call for about $3.59 and buy a September 20 $80 call for about $1.55. This trade generates a credit of $2.04, 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 $204. The credit received when the trade is opened, $204 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $296. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($204).

This trade offers a potential return of about 68% 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 LYB is below $75 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 $296 for this trade in LYB.