Earnings Sets Up a High Return, Relatively Low Risk Trade
A Brazilian financial technology company recently announced earnings. GlobeNewswire reported, “StoneCo Ltd. (Nasdaq: STNE), a leading provider of financial technology solutions that empower merchants to conduct commerce seamlessly across multiple channels, recently reported its financial results for the third quarter of 2019.”
The news pushed the stock out of a consolidation.
The news release continued, “Total Revenue and Income was R$671.1 million in the third quarter of 2019, an increase of 62.1% from R$414.1 million in the third quarter of 2018. Total Revenue and Income growth was driven primarily by the 49.8% increase in TPV combined with a higher take rate.
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Financial Income was R$335.1 million in the third quarter of 2019, an increase of 57.7% year over year, primarily due to the 49.8% growth in TPV year over year combined with a higher prepayment penetration.
Other Financial Income was R$48.0 million in the third quarter of 2019, an increase of R$41.6 million compared with the third quarter of 2018. This increase was mainly due to the interest income from the IPO proceeds on Stone’s cash balance and short-term investments.
Operating Costs and Expenses as a percentage of Total Revenue and Income decreased by 2.8 percentage points on a sequential basis to 42.5%, despite continued investments in our operation in 3Q19.
The company told shareholders:
“We reported another quarter of strong performance with continued top line growth and high profitability. I remain very excited to continue to implement our vision of becoming more present in our merchants’ daily activities, helping them to manage their businesses more effectively, become more productive and grow faster.
This quarter we reached a total base of 428,900 active clients and continued the roll-out of our new software, credit and banking solutions. We are looking forward to launching our integrated financial platform in the first quarter of 2020, which will represent an unparalleled combination of a unique financial platform with best-in-class customer service.
Despite our strong growth and expansion, I am pleased that we have continued to maintain our high NPS by staying focused on our client relationships, delivering a differentiated value proposition and providing high quality customer service across the organization. This is always our top priority.
We have also been able to attract many new talented people to join us in our journey through one of the biggest recruiting processes in the country.
We completed our 2019 recruiting process with a total of ~109,000 applications from people who wanted to work for Stone, compared to ~29,000 in 2018. We continue to be inspired and humbled by the strong demand of talented people across the country who want to join our mission and be part of our team.
As planned, we continued to invest in our operations during the quarter, but still benefited from improved operating leverage in business compared to the previous quarter, which continues to demonstrate the powerful efficiency and economics of our unique business model.”
The news pushed the stock to levels near its 52-week highs.
A Trade for Short Term Bulls
As with the ownership of any stock, buying STNE 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 STNE
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 STNE, the December 20 options allow a trader to gain exposure to the stock.
A December 20 $42 call option can be bought for about $2.25 and the December 20 $44 call could be sold for about $1.07. This trade would cost $1.18 to open, or $118 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 $118.
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 STNE the maximum gain is $0.82 ($44 – $42= $2; $2 – $1.18 = $0.82). This represents $82 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $118 to open this trade.
That is a potential gain of about 69% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.