Earnings Sets Up Yet Another Income Opportunity
Earnings announcements can increase the volatility of stocks. A recent example is seen on the earnings report of a financial firm. As PR Newswire reported, “Old Republic International (NYSE: ORI) released its earnings results on Thursday. The insurance provider reported $0.47 earnings per share for the quarter, beating analysts’ consensus estimates of $0.39 by $0.08.”
Old Republic International Corporation is a holding company. The company is engaged in business of insurance underwriting and related services.
The company conducts its operations through various regulated insurance company subsidiaries, which are organized into three segments: General Insurance Group, Title Insurance Group and the Republic Financial Indemnity Group (RFIG) Run-off Business.
The company’s General Insurance segment consists of property and liability insurance, and offers coverages to businesses, government and other institutions. The company’s Title Insurance Group business consists of the issuance of policies to real estate purchasers and investors based upon searches of the public records, which contain information concerning interests in real property.
The company’s RFIG run-off business consists of its mortgage guaranty and consumer credit indemnity (CCI) operations.
The news release continued, “Old Republic International had a return on equity of 9.61% and a net margin of 14.64%. The company had revenue of $1.76 billion during the quarter, compared to analyst estimates of $1.60 billion.
During the same quarter in the previous year, the company posted $0.45 EPS. Old Republic International’s revenue for the quarter was up 10.9% on a year-over-year basis.”
The stock’s recent volatility is notable on the chart.
One reason for the volatility could be the company’s exposure to the stock market. The earnings announcement noted,
“Since 2013, a significant portion of ORI’s investable funds have been directed toward the purchase of high-quality equity securities (common stocks) of U.S. companies. We favor the securities of issuers with long-term records of reasonable earnings growth and steadily increasing dividends.
As a result, dividends from equity securities have been the greatest source of investment income growth in recent years. The equities portfolio (currently limited to fewer than 100 issues) is also structured to contribute a measure of capital appreciation over time.
Periodic stress tests of this portfolio are made pursuant to enterprise risk management guidelines and controls. Their purpose is to gain reasonable assurance that periodic downdrafts in market prices, as typically occur in economic depression or recession conditions, would not seriously undermine ORI’s financial strength and the long-term continuity and prospects of the business.”
The strategy appears to have been rewarded by the stock market and the stock has been in an extended up trend. The gains have recently paused and a consolidation can be seen in the past few weeks on the next chart.
The stock price is now at the upper end of the consolidation range and a break to the up side could lead to a significant price move in the stock as technical traders move into the stock. That could lead to gains for traders, or it could be an income opportunity for risk averse traders.
Trading the Trend
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.
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 ORI
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.
For ORI, a bull put spread could be opened with the April 17 put options. This trade can be opened by selling the April 17 $24 put option for about $1.75 and buying the April 17 $22.50 put for about $0.72.
This trade would result in a credit of $1.03, or $103 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 $1.50 ($24 – $22.50). 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 $47 ($150 – $103).
The potential gain in ORI is about 119% of the amount of capital risked. This trade will be open for a relatively short amount of time 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.