Franklin Resources Sets a Growth Strategy That Could Deliver a 216% Gain
Trade summary: A bull call spread in Franklin Resources, Inc. (NYSE: BEN) using the July 17 $27.50 call option which can be bought for about $1.10 and the July 17 $30 call could be sold for about $0.50. This trade would cost $0.60 to open, or $60 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 $60. The maximum gain is $1.90 per contract. That is a potential gain of about 216% based on the amount risked in the trade.
Now, let’s look at the details.
Franklin Resources Inc. (NYSE: BEN) announced plans to acquire Legg Mason Inc. (NYSE: LM).
Bloomberg reported the details of the $4.5 billion deal. The combined company will be “a $1.5 trillion behemoth whose size trails only BlackRock Inc., Vanguard Group Inc., Fidelity Investments” and several other large companies.
The move could restore the company’s reputation.
BEN’s assets have “been stuck near $700 billion in assets under management for the past 18 months, down from a peak of $921 billion in mid-2014, while its competitors have grown steadily.
Moody’s Investors Service downgraded Franklin’s credit rating in mid-2018 and last year “expressed concern that Franklin’s reputation for global/international strategies and solid relative investment performance has been undermined.”
Analysts noted that,
“With the purchase, Franklin will strike an almost perfect balance between institutional and retail investors, which may help mitigate volatility in fund flows. Notably, it expects to maintain a nearly identical geographic focus, which is important given that some of its flagship offerings are worldwide in scope.
For example, the $26.3 billion Templeton Global Bond Fund holds a large position in Brazil’s bonds, and both Franklin and Legg Mason have a presence in Sao Paulo.”
The deal also provides the large firm with access to ETFs based on recent news that Legg Mason is taking a majority stake in Precidian, known for its ActiveShares exchange-traded funds.
“If successful, the products could upend the mutual-fund industry because they would trade daily and yet require reporting only once a quarter. Analysts have suggested some $7.2 trillion in mutual-fund strategies could work in this format.”
Franklin jumped on the news and is now potentially pushing out of an extended bottoming pattern.
But risks remain high as BEN is locked in a multiyear downtrend. Risks are high, but so are potential rewards.
Buying 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 BEN
For BEN, the July 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 July 17 $27.50 call option can be bought for about $1.10 and the July 17 $30 call could be sold for about $0.50. This trade would cost $0.60 to open, or $60 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 $60.
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 BEN the maximum gain is $1.90 ($30- $27.50= $2.50; $2.50 – $0.60 = $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 $60 to open this trade.
That is a potential gain of about 216% 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 BEN 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.
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.