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Trade summary: A bear call spread in ManpowerGroup Inc. (NYSE: MAN) using September $65 call options for about $6.70 and buy a September $70 call for about $3.80. This trade generates a credit of $2.90, 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 $210. 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 ($290). This trade offers a potential return of about 38% of the amount risked.
MAN was weak after reporting earnings.
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Now, let’s look at the details.
According to PR Newswire, MAN reported net losses of $1.10 per diluted share for the three months ended June 30, 2020 compared to net earnings of $2.11 per diluted share in the prior year period.
Net losses in the quarter were $64.4 million compared to net earnings of $127.3 million a year earlier. Revenues for the second quarter were $3.7 billion, a 30% decline from the prior year period.
The current year quarter included special items consisting of goodwill and other impairment, and discrete tax items, which reduced earnings per share by $1.28. Excluding these items, adjusted earnings per diluted share was $0.18 for the period.
Cash and cash equivalents at the end of the quarter equaled $1.4 billion, representing a $300 million increase from the preceding quarter, reflecting our committed focus on collections and working capital management.
With this ongoing focus, our Days Sales Outstanding improved year over year. A $600 million revolving credit facility, which expires in 2023, remained unused during the quarter and, combined with our existing cash position, provides significant liquidity.
Jonas Prising, ManpowerGroup Chairman & CEO, said, “The world continues to be impacted by COVID-19 which started as a health crisis and evolved to become a global economic and social crisis. While certain regions continue to deal with the pandemic at elevated levels, elsewhere lockdowns are easing, economies are slowly re-opening and people are returning to work.
“We anticipate diluted earnings per share in the third quarter will be between $0.59 and $0.67, which includes an estimated unfavorable currency impact of 1 cent and an elevated effective tax rate due to the French Business Tax which will have an unfavorable impact of 7 cents.
Our third quarter guidance reflects our assumptions as of today and does not anticipate any major rollbacks of economic reopening activities in any of our largest markets.”
The longer-term chart below shows that MAN has been trading lower since 2017 and the current problems are adding to the company’s challenges.
To benefit from expected weakness, traders could short the stock. Shorting shares of the stock, however, 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 MAN
For MAN, we could sell a September $65 call for about $6.70 and buy a September $70 call for about $3.80. This trade generates a credit of $2.90, 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 $290. The credit received when the trade is opened, $290 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $210. 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 ($290).
This trade offers a potential return of about 38% 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 MAN is below $65 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 $210 for this trade in MAN.
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.