Earnings Set Up Another Limited Risk Trade
Earnings reports often lead to quick moves in a stock. That’s fairly widely known among traders. Perhaps less well known is the fact that those short term moves often create additional trading opportunities. So there is no need to predict earnings. Profits are available for those who follow the news.
According to The Street, “Shares of cybersecurity firm Fortinet (Nasdaq: FTNT) were rising [sharply] after the company reported second-quarter earnings ahead of expectations and also issued guidance that topped forecasts.
Fortinet, Inc. is a network security company. The company provides cyber security solutions to a range of enterprises, service providers and government organizations across the world.
Its network security solution consists of FortiGate physical, virtual machine and cloud platforms, which provide integrated security and networking functions to protect data, applications and users from network-and content-level security threats.
The company’s product offerings consist of its FortiGate product family, along with its FortiManager central management and FortiAnalyzer central logging and reporting product families.
Its cybersecurity platform includes a range of products, which include its FortiMail e-mail security, FortiSandbox advanced threat protection (ATP), FortiWeb Web application firewall, FortiDDos and FortiDB database security appliances, as well as its FortiClient endpoint security software, FortiAP secure wireless access points and FortiSwitch secure switch connectivity products.
In the earnings announcement, “the company reported second-quarter adjusted earnings of 58 cents per share on revenue that jumped to $521.7 million from $441.3 million. Analysts were expecting the company to report earnings of 50 cents per share on revenue of $511.1 million.
“Our strong performance in the United States contributed to second-quarter billings growth that outpaced our competitors,” said CEO Ken Xie.
Those numbers were bolstered by strong third-quarter guidance of earnings between 55 cents and 57 cents per share on revenue between $525 million and $540 million per share. Analysts are expecting the company to report earnings of 53 cents per share on revenue of $523.9 million.
“We expect 2019 to be another year of better-than-industry growth, driven by our advanced security processing technology, new products and services offerings, and new market opportunities,” Xie said.”
The stock appears to be positioned for a breakout.
A Trade for Short Term Bulls
As with the ownership of any stock, buying FTNT 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 FTNT
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 FTNT, the September 20 options allow a trader to gain exposure to the stock.
A September 20 $90 call option can be bought for about $2.45 and the September 20 $95 call could be sold for about $1.08. This trade would cost $1.37 to open, or $137 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 $137.
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 FTNT the maximum gain is $3.63 ($95 – $90= $5; $5- 1.37 = $3.63). This represents $363 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $137 to open this trade.
That is a potential gain of about 164% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.