Earnings Matter and Can Create Triple Digit Opportunities
We often focus on trading after news. A recent example is seen in the stock of Universal Health Services, Inc. (NYSE: UHS). The stock jumped on earnings, and there could be a trading opportunity even now, after the news.
Perhaps most importantly, the trading opportunity is limited in risk. We will explain after reviewing the news.
As PR Newswire reported, Universal Health Services, Inc. recently announced that its reported net income attributable to UHS was $238.3 million, or $2.66 per diluted share, during the second quarter of 2019 as compared to $226.1 million, or $2.39 per diluted share, during the comparable quarter of 2018.
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Net revenues increased 6.5% to $2.855 billion during the second quarter of 2019 as compared to $2.681 billion during the second quarter of 2018.
The Street added that the “health care management company reported second-quarter adjusted earnings of $2.76 a share vs. the consensus estimate of $2.50, according to FactSet. Revenue was $2.86 billion vs. the $2.81 billion FactSet consensus.
The board approved a $1 billion increase to its stock-repurchase program, and it doubled the quarterly dividend to 20 cents a share.
The company said it would pay $127 million to settle with the Justice Department’s Civil Division investigating its behavioral health-care facilities on behalf of various states’ attorneys general.
All investigations by the DoJ’s Criminal Frauds Section in connection with these matters have been closed, the company said it was advised.
ModernHealthCare.com explained, “For at least five years, the Justice Department has led both civil and criminal investigations into UHS’ behavioral health operations, but both the government and the hospital chain have been tight-lipped about the contents of those inquiries.
Meanwhile, BuzzFeed began posting articles in December 2016 about UHS’ mistreatment of behavioral health patients, describing a pattern of involuntary admissions in cases where it allegedly was not justified to increase reimbursement.
That same month, Sen. Chuck Grassley (R-Iowa) asked HHS’ Inspector General for more information, citing the news reports.
The civil investigation pertains to allegations that some of UHS’ facilities submitted false claims for reimbursement to the government.
More specifically, the government has investigated whether UHS delayed patient discharges from its behavioral health facilities to maximize reimbursement, said Brian McGovern, a partner with Crowell and Moring in New York.
He added that issues over UHS’ admissions standards could overlap with discharge standards.
UHS’ CEO, Alan Miller, chimed in on [a recent] investor call to emphasize that he and the rest of UHS’ leadership team are in the clear.
“The criminal investigation also came to absolutely nothing,” he told one analyst. “So you’ll have to deal with the existing management for a while.”
UHS said the DOJ still must approve the civil settlement, which UHS said was also on behalf of various states’ attorneys general. HHS OIG will then issue a corporate integrity agreement, which will issue mandatory compliance standards going forward.
Corporate integrity agreements typically last five years and almost always require the company, at its own expense, to hire an outside firm to monitor compliance with the terms, McGovern said.
The cost of doing that will probably be less than the $10 million that [one analyst] said UHS has spent annually to defend itself in the DOJ investigations, but that depends on its provisions.
“The devil will be in the details as to how onerous and how closely the outside organization will be monitoring their business practices,” McGovern said.
Once it’s released, the corporate integrity agreement will be public, McGovern said.”
The stock could now move significantly higher.
A Trade for Short Term Bulls
As with the ownership of any stock, buying UHS 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 has 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.
A Specific Trade for UHS
Every day, we scan the markets looking for trades with 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.
For UHS, the October 18 options allow a trader to gain exposure to the stock.
An October 18 $155 call option can be bought for about $5.12 and the October 18 $160 call could be sold for about $2.69. This trade would cost $2.43 to open, or $243 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 $243.
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 UHS the maximum gain is $2.57 ($160 – $155= $5; $5 – $2.43 = $2.57). This represents $257 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $243 to open this trade.
That is a potential gain of about 105% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.