Etsy Could Offer a 77% Short Term Gain
Trade summary: A bull call spread in Etsy, Inc. (Nasdaq: ETSY) using the November $155 call option which can be bought for about $12.65 and the November $160 call could be sold for about $10.85. This trade would cost $1.80 to open, or $180 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $180. The maximum gain is $320 per contract. That is a potential gain of about 77% based on the amount risked in the trade.
Now, let’s look at the details.
The Street carried news that “ETSY shares rose sharply after Needham analyst Rick Patel predicted sustained revenue growth for the online crafts retailer amid the coronavirus pandemic”.
The report continued, “He has a buy rating and a $150 share-price target on the Brooklyn, N.Y., company.
Etsy’s stock recently traded at $147.07, up 5.4%. It has well more than tripled year to date.
“The pandemic is benefiting Etsy through an uptick in digital demand while also creating a window of opportunity to capture new customers looking to buy masks” to cope with the pandemic, Patel wrote in a commentary cited by Bloomberg.
Etsy, which is 15 years old, began as an arts and crafts store. But now, even masks are part of its inventory. Sales more than doubled in the second quarter from a year earlier.
Demand for masks was “robust in the third quarter, which we believe should benefit Etsy” as it did in the second quarter, Patel said.
Etsy is making “good progress in retaining” new customers who have joined during the pandemic, he said.
Last month, BTIG analyst Marvin Fong upgraded Etsy to buy from neutral with a $138 price target. A drop to that level “brings its valuation into historical range,” he said.
The analyst called Etsy “one of the fastest growing and best run companies in e-commerce.” He said the company’s August growth appeared robust.
Meanwhile, Jefferies analyst John Colantuoni has a buy rating and $163 price target on the company.
“Our analysis of traffic and search trends so far in the third quarter suggest Etsy’s elevated top-line growth remains unabated,” Colantuoni said.
That “[supports] our view that the pandemic has driven a permanent uplift in online consumption, particularly in categories related to home nesting where the company is particularly strong.”
ETSY has now cleared resistance and could continue higher although there are risks of a pullback. Nearby support is at about $100 which means there is significant risk in the stock.
A Specific Trade for ETSY
For ETSY, the November options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A November $155 call option can be bought for about $12.65 and the November $160 call could be sold for about $10.85. This trade would cost $1.80 to open, or $180 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 $180.
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 ETSY, the maximum gain is $320 ($160- $155= $5; 5- $1.80 = $3.20). This represents $320 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $180 to open this trade.
That is a potential gain of about 77% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying ETSY 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 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 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.