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Earnings Miss and Traders Can Win

Earnings Miss and Traders Can Win

Alliance Data Systems Corporation (NYSE: ADS), a leading global provider of data-driven marketing and loyalty solutions, announced results for the quarter ended June 30, 2019. PR Newswire reported,

Revenue decreased 3 percent to $1.35 billion, while EPS decreased 33 percent to $2.71 for the second quarter of 2019. The higher effective tax rate for EPS, 27 percent, compared to 15 percent for the second quarter of 2018, reduced EPS by approximately $0.43 for the second quarter.

Core EPS decreased 12 percent to $3.83 for the second quarter of 2019, while adjusted EBITDA, net decreased 15 percent to $310 million for the second quarter of 2019.

The stock made a sharp reversal on the news.

ADS daily chart

LoyaltyOne revenue increased 1 percent to $251 million, while adjusted EBITDA decreased 27 percent to $51 million for the quarter ended June 30, 2019.

Revenue increased 10 percent compared with the prior year when adjusted for unfavorable foreign exchange rates and additional product redemptions now recorded as net revenue.

Adjusted EBITDA, net decreased 23 percent on a constant currency basis due to higher redemption costs at AIR MILES, which is largely a function of product mix redeemed.

AIR MILES reward miles issued decreased 2 percent for the second quarter of 2019, primarily due to less promotional activity in the grocery vertical.

In Card Services, revenue decreased 4 percent to $1.10 billion and adjusted EBITDA, net decreased 14 percent to $287 million for the second quarter of 2019.

Gross yields decreased 90 basis points to 23.9 percent on essentially flat normalized average card receivables growth (card receivables plus held-for-sale receivables).

The loan loss provision decreased 17 percent to $257 million as a result of a 7 percent decrease in reservable card receivables and a 30 basis point improvement in principal loss rates.

Operating expenses increased $35 million to $472 million, primarily due to an approximate $26 million increase in mark-to-market charges on held-for-sale receivables.

Excluding the mark-to-market charges, operating expenses expressed as a percentage of normalized average card receivables increased approximately 25 basis points to 9.4 percent. During the quarter, over $900 million in credit card receivables were acquired from third parties, while approximately $510 million in credit card receivables were reclassified as held-for-sale.

Melisa Miller, president and chief executive officer of Alliance Data, commented, “We continued to execute on our business transformation in the second quarter and made progress on delivering our strategic plan to lead the market in the convergence of payments, data and marketing.

Our second quarter results were mostly in line with expectations, although core EPS was negatively impacted by the timing of credit card portfolio acquisitions. We acquired several client portfolios aggregating over $900 million in June, which were expected to occur later in the year.

While this pull-forward supports our receivables growth projections for the year, the impact of the provision build post-acquisition reduced second quarter core EPS.”

The stock has been in a long term down trend.

ADS 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 ADS

For ADS, we could sell a September 20 $150 call for about $7.15 and buy a September 20 $155 call for about $4.40. This trade generates a credit of $2.75, 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 $275. The credit received when the trade is opened, $275 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $225. 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 ($275).

This trade in ADS offers a potential return of about 122% in 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 ADS is below $150 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 $225 for this trade in ADS.