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This Earnings Miss Provides a Chance for Bulls to Win

This Earnings Miss Provides a Chance for Bulls to Win

U.S. Silica Holdings, Inc. (NYSE: SLCA) is a leading producer of commercial silica used in the oil and gas industry as well as in a vast spectrum of industrial applications. The company’s most recent earnings per share (EPS) of $0.51 was shy of analysts’ expectations of $0.55.

But, the company reported revenue, of $360.6 million, nearly double the revenue of the same three months a year ago and also ahead of expectations which were for $359.2 million.

Silica is widely used as a proppant for fracking, a use that now accounts for the majority of SLCA’s sales. Proppant is used to “prop open” the fractures made in the rock formation so that oil and gas can flow to the well. As fracking increased, the use of proppants increased and that should benefit SLCA.

The rest of the company’s sales come from industrial and specialty products. Major customers of this operating division include Sherwin Williams which uses silica in paint and Owens Corning which requires silica to produce glass, including the glass needed for smart phones.

While the industrial and specialty products division is important to SLCA, proppants offer the most potential for growth. Because fracking requires large amounts of proppants, drillers need reliable partners capable of making large deliveries.

In the past, small, locally owned sand pits could supply customers but that has changed since tons of sand are required every day by large customers. SLCA is benefiting from this trend towards industry consolidation

The company has more than a dozen facilities located around the country and is well positioned to move their product to the customer’s location. The company also owns a number of railcars.

Railroads are a major source of transportation in oil fields. Oil is moved by rail in many cases and silica can be shipped back into the fields, at a low cost, as railcars are returned to the fields.

The ability to transport sand over large distances at a low price ensures that SLCA will maintain its position of leadership in the industry. But, its stock price will be volatile, as it has been in the past.

SLCA weekly

Oil Could Spur the Stock’s Next Up Move

The next chart overlays the price of crude oil on the price of SLCA. There is a strong correlation for most of the time period shown, but SLCA tends to rally when the price of oil falls into a trading range.

SLCA weekly

For now, oil appears to be trading in the upper portion of a multiyear trading range. An up side breakout would drive SLCA higher. A continuation of the range is also likely to be bullish for SLCA since high prices, and the upper half of the range is a high price, encourages fracking.

The company will continue to support fracking and expects its capital expenditures for 2018 to be in the range of $300-$350 million, mainly due to continued investments in sand extraction activities and completion of capacity expansion projects started last year.

For the first quarter, the company expects flat volumes and pricing in the energy market compared to fourth-quarter 2017. Per the company, severe winter weather has resulted in delaying of completion activities and also caused disruptions in the customer supply chain.

This indicates surprises are likely to be to the up side.

The selloff in SLCA could be overdone since traders are unlikely to abandon trades that offer exposure to the fracking market.

Trading A Potential Uptrend

When a stock is expected to move higher, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.

Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up trend.

bull put spread

Source: The Options Industry Council

This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.

Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.

Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.

A Specific Trade for SLCA

For SLCA, a bull put spread could be opened with the March 16 put options. This trade can be opened by selling the March 16 $24 put option for about $0.55 and buying the March 16 $23 put for about $0.25.

This trade would result in a credit of $0.30, or $30 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.

The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $1.00 ($24 – $23). This is multiplied by 100 since each contract covers 100 shares.

Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $70 ($100 – $30).

The potential gain is about 43% of the amount of capital risked. This trade will be for about one month and the annualized rate of return provides a significant gain.

The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.

These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.