Earnings Season Gets Off to a Weak Start and Creates a 78% Gain
Trade summary: A bear call spread in Verint Systems Inc. (Nasdaq: VRNT), using April 17 $35 call options for about $3.40 and buy an April 17 $40 call for about $0.80. This trade generates a credit of $2.60, which is the difference in the amount of premium for the call that is sold and the call.
In this trade, the maximum risk is about $240. 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 ($260). This trade offers a potential return of about 78% of the amount risked.
Now, let’s look at the details.
Lost in the news of the coronavirus is the fact that many routine parts of life are continuing. For publicly traded companies, the routine includes releasing quarterly earnings reports and that is a process that will be unfolding over the next few weeks.
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Companies don’t all use the same fiscal year and among the companies that aren’t on the traditional calendar is VRNT. The company’s fiscal year ended in January and management recently provided results for that quarter.
Verint Systems Inc. offers Actionable Intelligence solutions. The company delivers its Actionable Intelligence solutions through two operating segments: Customer Engagement Solutions and Cyber Intelligence Solutions.
It is a provider of customer engagement software and services that can be deployed on-premises or in the cloud. Its Customer Engagement vision is powered by its Actionable Intelligence platform to generate intelligence from structured and unstructured data.
It offers solutions that help organizations empower their customers and employees through intelligence that can be shared enterprise wide. It is a provider of security and intelligence data mining software.
Its solutions are used for a range of applications, including predictive intelligence, advanced and complex investigations, security threat analysis, and electronic data and physical assets protection, as well as for generating legal evidence and preventing criminal activity and terrorism.
As MarketWatch reported,
“Verint Systems Inc. … reported fourth quarter revenue below consensus estimates. The company reported fourth quarter net income of $4.9 million, or 7 cents a share, compared with $27.3 million, or 41 cents a share, in the year ago period.
The stock sold off on the news.
MarketWatch continued, “Adjusted for items such as stock-based compensation, earnings were $1.11 a share. Revenue rose to $339.2 million from $330.2 million in the year ago period. Analysts surveyed by FactSet had estimated adjusted earnings of $1.16 a share on revenue of $374.4 million.
For the first quarter, analysts modeled earnings of 79 cents a share and revenue of $339.3 million.”
Business Wire offered insight from the company’s CFO who said, “Verint has a large customer base of more than 10,000 customers around the world and a very strong and differentiated portfolio. We had a successful FY20 and entered FY21 with a strong outlook.
At this point, considering the rapidly changing conditions arising from COVID-19 and uncertainty about its potential impact, we are unable to provide guidance.”
Without strong guidance, the chart indicates the stock is likely to sell off.
To benefit from weakness, traders could short the stock. Shorting shares of the stock exposes traders to significant risks in dollar terms. A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.
A Specific Trade for VRNT
For VRNT, we could sell an April 17 $35 call for about $3.40 and buy a April 17 $40 call for about $0.80. This trade generates a credit of $2.60, 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 $260. The credit received when the trade is opened, $260 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $240. 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 ($260).
This trade offers a potential return of about 108% 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 VRNT is below $35 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 $240 for this trade in VRNT.
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.
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.