Fewer Dental Visits Creates a 57% Income Opportunity
Trade summary: A bear call spread in Henry Schein, Inc. (Nasdaq: HSIC) using August $65 call options for about $3.33 and buy an August $67.50 call for about $1.80. This trade generates a credit of $1.53, 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 $97. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($153). This trade offers a potential return of about 57% of the amount risked.
Now, let’s look at the details.
As Business Wire noted, HSIC describes itself as “the world’s largest provider of health care solutions to office-based dental and medical practitioners.”
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The company recently reported its results for the second quarter, a time period which included significant lockdowns and cancellation of nonessential medical and dental treatments in many parts of the country,
Net sales for the quarter ended June 27, 2020, were $1.7 billion, a decrease of 31.2% compared with the second quarter of 2019 due to the impact of COVID-19. In local currencies, internally generated sales decreased 30.5%.
GAAP net loss from continuing operations for the quarter was $11.4 million, or a loss of $0.08 per diluted share, compared with prior-year net income from continuing operations of $116.8 million, or $0.78 per diluted share.
Non-GAAP net income from continuing operations for the second quarter of 2020 was $0.6 million, or $0.00 per diluted share, compared with prior-year non-GAAP net income from continuing operations of $125.7 million, or $0.84 per diluted share.
“Team Schein rose to the significant challenges caused by the global COVID-19 pandemic. These efforts are clear attributes of our corporate culture, which is rooted in care and respect for one another, as well as a commitment to our customers, suppliers, investors, and corporate social responsibility,” said Stanley M. Bergman, Chairman of the Board and Chief Executive Officer of Henry Schein.
“While results for the second quarter are reflective of the current challenging environment, we remain confident in our strategy. Throughout this pandemic, we have focused our dental and medical practice recovery programs to assist our customers with solutions ranging from management of temporary office closures to practice safety, new protocol implementation, patient communications, and financial assistance, among many other solutions to help restore practices.
Regarding our second quarter financial results, COVID-19 significantly impacted our worldwide results, particularly in our Dental business.”
Traders seemed disappointed and sold on the news, pushing the stock down slightly.
The selloff comes as the stock challenges resistance. This was the fourth attempt to break above 2017 highs and could lead to significant selling as traders worry that further upside is limited.
Shorting shares of the stock 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 HSIC
For HSIC, we could sell an August $65 call for about $3.33 and buy an August $67.50 call for about $1.80. This trade generates a credit of $1.53, 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 $153. The credit received when the trade is opened, $153 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $97. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($153).
This trade offers a potential return of about 57% 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 HSIC 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 $97 for this trade in HSIC.
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.