Ferrari Could Provide a Win of 61% to Traders
Trade summary: A bull call spread in Ferrari N.V. (NYSE: RACE) using the June 17 $160 call option which can be bought for about $8.50 and the June 17 $165 call could be sold for about $5.40. This trade would cost $3.10 to open, or $310 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 $3.10. The maximum gain is $190 per contract. That is a potential gain of about 61% based on the amount risked in the trade.
Now, let’s look at the details.
Forbes reported on RACE’s earnings, noting the company reported EBITDA profits of 1.27 billion euros ($1.4 billion) in 2019 and restarted operations at its plants in Maranello and Modena. It reported first quarter adjusted EBITDA rose 1.9% to 317 million euros ($350 million).
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The stock was up on the news.
Morgan Stanley analyst Adam Jonas said in a research note lauded the company, “This extraordinary level of stability in an economic crisis takes top place at the podium and expect investors to use any weakness as a buying opportunity,”
Interestingly, CNBC noted, Ferrari is now worth more than General Motors or Ford, after its market value surged Monday morning to about $30 billion.
Ferrari’s shares jumped as much as 7% on Monday, after the Maranello, Italy-based sports car maker reported better-than-expected earnings. Despite shutting its factory in March, the company’s total shipments of cars increased 5% to 2,738. Revenue fell only 1% to $1.02 billion — better than the $852 billion analysts expected.
The company also restarted its factories in Maranello and Modena on Monday, and are expected to return to full production on Friday.
Even though Ferrari makes only 10,000 cars a year, compared with General Motors’ production of about 7.7 million vehicles last year, investors are betting that Ferrari’s storied brand name and hefty prices and profit margins are likely to power the stock through the coronavirus crisis better than other auto brands.
Ferrari’s market capitalizaton hit $30.1 billion in early trading Monday, after settling back to $29.8 billion later in the day. General Motors’ market cap fell to under $29.3 billion while Ford’s fell to $19.2 billion. Fiat Chrysler, which spun out Ferrari in 2015, has seen its market cap decline to under $13 billion. Ferrari’s share price has more than tripled since it went public.
While Ferrari reduced its earnings forecast for the year, and warned of continued weakness from its Formula One business and other segments in the second quarter, investors were cheered by its relatively mild revisions to the year ahead.
The stock could now challenge its recent highs after holding up fairly well in the market selloff.
A Specific Trade for RACE
For RACE, the June 17 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 June 17 $160 call option can be bought for about $8.50 and the June 17 $165 call could be sold for about $5.40. This trade would cost $3.10 to open, or $310 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 $3.10.
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 RACE the maximum gain is $1.90 ($165- $160= $5; 5- $3.10 = $1.90). This represents $190 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $310 to open this trade.
That is a potential gain of about 61% 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 RACE 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 RACE 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.