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Earnings Could Sink this Stock and Boost Traders’ Account Balances

Earnings Could Sink this Stock and Boost Traders’ Account Balances

Bad earnings reports aren’t necessarily ones with bad news. A bad report could simply be one that traders perceive to be lackluster.

An example, as Business Wire recently reported, is in LivaNova PLC (Nasdaq: LIVN) preliminary unaudited revenue results for the quarter ended March 31, 2019.

The company is a medical device company focused on the development and delivery of therapeutic solutions.

The Cardiac Surgery segment is engaged in the development, production and sale of cardiovascular surgery products. Cardiac Surgery products include oxygenators, heart-lung machines, autotransfusion, mechanical heart valves and tissue heart valves.

The Neuromodulation segment is engaged in the design, development and marketing of neuromodulation therapy for the treatment of drug-resistant epilepsy and treatment resistant depression.

Management expects worldwide sales from continuing operations for the first quarter 2019 to be approximately $251 million, flat on a reported basis and an increase of 4.0 percent on a constant-currency basis compared to the first quarter of 2018.

Neuromodulation sales are anticipated to be $94 million, up 0.6 percent on a reported basis and an increase of 2.1 percent for the first quarter of 2019 compared to the same period last year.

Cardiovascular sales are expected to be $155 million, down 0.5 percent on a reported basis and an increase of 5.1 percent for first quarter 2019 as compared to the same period last year.

In Cardiovascular, LivaNova ended a previously disclosed third-party distribution agreement on January 1, 2019 that accounted for $8 million in sales in the first quarter of 2018 and is located in Cardiopulmonary within the Rest of World region.

The Neuromodulation business experienced unexpected weakness in the U.S. market due to a combination of factors, including competitive dynamics and salesforce turnover. Softness in Perceval sales coupled with continued declines in overall heart valve sales negatively impacted the Cardiovascular business during the quarter.

“While our Europe and Rest of World regions continued to grow above plan, I am disappointed by our execution in the quarter in light of the changing competitive environment within the U.S. in our Neuromodulation and Heart Valves businesses,” said Damien McDonald, Chief Executive Officer of LivaNova.

“We believe we can address these challenges and remain committed to our strategy to drive sales, build global capabilities and establish a strong product portfolio. We believe these efforts will serve the needs of our customers and patients to create quality, long-term value for our shareholders.”

Looking ahead, LivaNova is currently reviewing its 2019 guidance and will provide updates and report its full financial results for first quarter 2019 in connection with its earnings call on Wednesday, May 1.

Traders seemed disappointed with the news.

LIVN daily chart

The decline pushed prices below the lower edge of an extended trading range, a bearish signal.

LIVN weekly chart

A Trading Strategy to Benefit From Potential Weakness

The prospects of further short-term gains in LIVN seem to be remote.  But, significant weakness is also unlikely. Traders should consider using an options strategy known as a bear put spread to benefit from the expected trading range in the stock.

This strategy can be profitable when a trader is looking for a steady or declining stock price during the term of the options. The risks and potential rewards of this strategy are illustrated in the payoff diagram shown below.

bear put spread

Source: The Options Industry Council

A bear put spread consists of buying one put and selling another put at a lower exercise price to offset part of the initial cost of the trade. This trading strategy generally profits if the stock price moves lower. The potential profit is limited, but so is the risk should the stock unexpectedly rally.

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.

The Trade Specifics for LIVN

The bearish outlook for LIVN, at least for the purposes of this trade, is a short-term opinion. To benefit from this outlook, traders can buy put options.

A put option gives the trader the right, but not the obligation, to sell shares at a specified price until the option expire. While buying a put is possible, it can also be expensive.  The risk of loss when buying an option is equal to 100% of the amount paid for the option.

To limit the risks, a second put can be sold. This will generate income that can offset the purchase price, potentially allowing a trader to buy a put with a higher exercise price. That increases the probability of success for the trade.

Specifically, the April 18 $75 put can be bought for about $6.85 and the April 18 $70 put can be sold for about $2.82. This trade will cost about $4.03 to enter, or $403 since each contract covers 100 shares, ignoring the cost of commissions which should be small when using a deep discount broker.

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 $403. This loss would be experienced if LIVN is above $75 when the options expire. In that case, both options would expire worthless.

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 LIVN, the maximum gain is $0.97 ($75 – $70 = $5; $5 – $4.03 = $0.97). This represents $97 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $403 to open this trade.

That is a potential gain of about 24% of the amount risked in the trade. This trade delivers the maximum gain if LIVN closes below $70 on April 18 when the options expire.

Put 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 $403 for this trade in LIVN.