Earnings Season, Again
With the holidays approaching, a number of traders are preparing for an equally important season in the trading calendar. Earnings reports will start appearing in the news again. Among the companies announcing earnings will be Nike’s (NYSE: NKE).
The stock price has gained about 17% since the last earnings report was released. That news led investors to become more optimistic about the company’s business strategy. Now, investors will learn if that optimism was warranted when the company reports earnings after the close on December 21.
Investors will be watching the earnings report and the conference call management holds after the report is released. They will be comparing the actual numbers to expectations.
Slowing Growth Has Led to Lowered Expectations
The share price of NKE, shown in the long term chart below, reflects the company’s transition from a rapidly growing company to its current position as a slow growing market leader.
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The stock price delivered large gains until 2015 when investors realized growth was slowing for the shoe giant. As recently as 2012, sales grew 16%. Now, sales growth is unchanged over the past twelve months when compared to the same period a year earlier.
Looking ahead, analysts expect NKE to report sales growth of 2.6% this quarter, 4.2% for the full year and about 6% in the next fiscal year which ends in May 2019.
Management has told analysts their expectations for growth should be low. In last quarter’s conference call with analysts, Nike Chief Financial Officer Andy Campion said, “We believe there will be short-term headwinds within the U.S. retail landscape that will dampen growth.”
Management is optimistic about sales growth related to its digital efforts to make sales direct to consumers. Currently, digital sales represent 15% of the company’s revenue and management expects the sales channel to account for 30% of its revenue in the next five years.
This would help the company increase its profit margins. Gross profit margins have declined by about 150 basis points, to 44.1% in the most recent twelve months. Rising costs have hurt the company and growth in earnings per share has been fueled by share buy backs.
Analysts are optimistic about some aspects of the company’s business. They believe the company’s running shoes may be star performers. Foot Locker reported that Nike’s VaporMax and Air Max 97 were some of the strongest sellers in footwear.
This confirms the trend Nike reported in its most recent results. Last quarter, Nike reported that Air VaporMax holds the top market share position for running shoes selling at $150 a pair or higher.
Foot Locker also gave analysts hope that basketball shoes would also deliver strong performance. The retailer noted that it saw an improving trend in the sector, specifically with Nike’s Jordan Retro seeing stronger sales in the recent quarter.
History Forecasts an Earnings Beat and a Surprising Stock Reaction
Overall, Nike has been a company that on average delivers earnings that beat expectations. On average, the company has beaten expectations by 20.8% over the past five years. The company has beaten expectations in each of the past twenty quarters.
The strong performance has led to what might be an unexpected market reaction. When a company beats expectations, we generally expect a stock price to move higher. However, on average, NKE has been unchanged a week after the earnings report.
The next chart shows the short term action in the stock price. Three months ago, in the most recent earnings report, Nike beat expectations by $0.09 per share with earnings per share of $0.57. The stock continued trading within the range it had been locked into for weeks before the announcement.
After the strong gain over the past few months, we could see a similar trend unfold this time. The earnings report could be followed by a trading range.
One options strategy that benefits from a stock in a trading range is an iron condor. This strategy has the added benefit of carrying limited risk.
To open an iron condor trade, the investor sells one call while buying another call with a higher exercise price and sells one put while buying another put with a lower exercise price. Typically, the exercise prices of the calls are above the market price of the stock and the exercise prices of the put options are below the current price of the underlying stock.
In an iron condor, the difference between the exercise prices of the two call options will be equal to the difference between the exercise prices of the two put options. The final requirement for this strategy is that all of the options must have the same expiration date.
The risks and potential rewards of the strategy are shown in the following diagram.
Source: The Options Industry Council
The maximum gain on this trade is equal to the premiums received when the position is open. The maximum risk is equal to the difference in the two exercise prices less the amount of the premium received when the trade was opened.
Opening an Iron Condor in Nike
For Nike, the trade can be opened using the following four options contracts:
As you see, all of the options expire on the same day, Friday, January 12.
The difference in the exercise prices of the calls or puts is equal to $2.00. Since each contract covers 100 shares of stock, this means the maximum risk on the trade is equal to $200 less the premium received when the trade was opened.
Selling the options will generate $1.48 in income ($0.90 from the call and $0.58 from the put). Buying the options will cost $0.63 ($0.37 for the call and $0.26 for the put). This means opening the trade will result in a credit of $0.85, or $85 for each contract since each contract covers 100 shares.
The maximum risk on the trade is equal to the difference in strike prices ($3.00) minus the premium received ($0.85). This is equal to $2.15, or $215 since each contract covers 100 shares. Many brokers will require a margin deposit equal to the amount of risk. That means this trade may require just $215 in capital.
The maximum gain on the trade is the amount of premium received when the trade is opened. In this case, that is $0.85 or $85 per contract.
The potential reward on the trade ($85) is about 40% of the amount risked, a high potential return on investment for a trade that will be open for less than one month. If a trade like this is entered every month, a small trader could quickly increase the amount of capital in their trading account.
The iron condor is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that should be lower than owning the stock.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.