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Earnings Spark a Rally, Set Up Possible 381% Gain

Earnings Spark a Rally, Set Up Possible 381% Gain

The news was straightforward even though the trading opportunity might be considered unusually attractive.

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  • Business Wire reported, that State Street Corporation (NYSE: STT) recently reported earnings:

    “Investment Servicing AUC/A as of quarter-end decreased 3% primarily due to the near-completion of a previously announced client transition, partially offset by higher market levels.

    Investment Management AUM as of quarter-end increased 7% driven by higher equity markets and growth from institutional and ETF inflows, partially offset by cash outflows.

    Investment Servicing mandates announced in 2Q19 totaled $390 billion with quarter-end servicing assets remaining to be installed in future periods of $575 billion.”

    The stock jumped on the news.

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  • STT daily chart

    Business Wire continued, “Front-to-back investment servicing demand increasing with first major announcement and strong pipeline. Investment Management net inflows in 2Q19 of $20 billion driven by institutional and cash.

    Charles River Development (CRD) mandates in 2Q19 included annual contract value bookings of $31 million, including SSGA bookings.

    Fee revenue decreased 6% reflecting lower servicing, management and markets revenues, partially offset by CRD: compared to 1Q19, fee revenue was flat reflecting primarily stable servicing fees, higher management fees and lower processing fees. CRD generated $91 million in 2Q19 fee revenues and $45 million in pre-tax operating income before associated amortization expense and acquisition costs.

    Total expenses were down 1%, primarily reflecting the absence of prior year repositioning costs as well as savings from process re-engineering and resource discipline related to our expense savings program, partially offset by the impact of CRD expenses and increased technology investments;

    Excluding notable items, seasonal and CRD-related expenses, total expenses were down 1% compared to 2Q18 and were largely flat compared to 1Q19.

    Expense savings program announced in January 2019 achieved $175 million total savings year-to-date through resource discipline, process re-engineering and automation benefits.

    Total headcount increased 4% compared to 2Q18 driven by the impact of CRD and shift to low cost locations.

    Ron O’Hanley, President and Chief Executive Officer: “State Street is acting with urgency to adjust to a challenging external environment. We remain laser focused on steps we can immediately take both to improve financial performance and strengthen client service, including enhanced productivity, process re-engineering and greater resource discipline.

    Our 2019 expense program has delivered $175 million in savings year-to-date and we now expect to achieve a total of $400 million by year-end.

    On the revenue side, gross client wins were strong with almost $400 billion of new assets. I am encouraged by the continued momentum with Charles River Development, both in terms of new business on its platform but also due to the depth of the discussions we are having with a range of clients on adopting our leading front-to-back platform.

    We saw some moderation in industry headwinds and more stable fee revenues as we actively and systematically engage with clients.

    Moreover, our CCAR results were encouraging, confirming the effectiveness of our balance sheet repositioning last year and allowing us to increase capital return to shareholders.”

    The stock could be rallying from a significant bottom.

    STT weekly chart

    A Trade for Short Term Bulls

    As with the ownership of any stock, buying STT 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.

    bull call spread

    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 STT

    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 STT, the August 16 options allow a trader to gain exposure to the stock.

    An August 16 $62.50 call option can be bought for about $0.67 and the August 16 $65 call could be sold for about $0.24. This trade would cost $0.43 to open, or $43 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 $43.

    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 STT the maximum gain is $2.07 ($65 – $62.50= $2.50; $2.50 – $0.43 = $2.07). This represents $207 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $43 to open this trade.

    That is a potential gain of about 381% in STT based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

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