Goosehead’s 14% Gain Could Point to a 254% Gain
Trade summary: A bull call spread in Goosehead Insurance, Inc (Nasdaq: GSHD) using the November $125 call option which can be bought for about $5.60 and the November $130 call could be sold for about $4.50. This trade would cost $1.10 to open, or $110 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 $110. The maximum gain is $390 per contract. That is a potential gain of about 254% based on the amount risked in the trade.
Now, let’s look at the details.
GSHD jumped after announcing earnings.
Goosehead Insurance, Inc. is a rapidly growing independent personal lines insurance agency.
It offers various insurance products, including homeowner’s insurance; auto insurance; other personal lines products, such as flood, wind, and earthquake insurance; excess liability or umbrella insurance; specialty lines insurance comprising motorcycle, recreational vehicle, and other insurance; commercial lines insurance consisting of general liability, property, and auto insurance for small businesses; and life insurance.
GlobeNewswire reported that revenues grew 51% to $32.0 million in the third quarter of 2020, compared to $21.2 million in the third quarter of 2019.
Net income of $6.7 million; net income attributable to Goosehead Insurance, Inc. of $3.3 million or $0.19 per basic share and $0.17 per diluted share.
Total written premiums placed increased 49% from the prior-year period to $301 million.
Policies in force grew 47% from the prior-year period to 657,000.
Corporate sales headcount of 371 was up 60% year-over-year.
Total franchises increased 52% compared to the prior year period to 1,261; total operating franchises grew 41% compared to the prior-year period to 823.
“Goosehead delivered another phenomenal quarter with sustained high levels of growth, profitability, and high retention driven by world-class client service. Our results continue to validate the substantial and consistent investments we have made in people and technology to improve our already unmatched platform,” stated Mark E. Jones, Chairman and Chief Executive Officer of Goosehead.
“We have remained aggressively on offense and relentlessly externally focused on our clients and partners throughout the unique challenges that 2020 has presented. Independent agency distribution in US personal lines is positioned for future expansion, and our choice model, knowledgeable agents, best-in-class service, and industry leading proprietary technology are providing a superior client experience that we believe will drive continued significant share gains for Goosehead.
Given the strength of our results through the first nine months of the year, we are pleased to raise our full-year outlook for total written premium and revenue. I am extremely proud of the determination and tireless focus of our people to continue to deliver for our clients and shareholders in these unprecedented times.”
Management noted that, “based on our experience to date, the Company is raising its full-year 2020 outlook with respect to total written premiums and revenue:
Total written premiums placed for 2020 are expected to be between $1.05 billion and $1.07 billion, representing organic growth of 42% on the low end of the range to 45% on the high end of the range.
Total revenues for 2020 under ASC 606 revenue accounting are expected to be between $109 million and $112 million, representing organic growth of 41% on the low end of the range to 45% on the high end of the range.
The stock broke out to new highs on the news and a price target of $160 is in reach based on the recent pattern.
A Specific Trade for GSHD
For GSHD, 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 $125 call option can be bought for about $5.60 and the November $130 call could be sold for about $4.50. This trade would cost $1.10 to open, or $110 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 $110.
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 GSHD, the maximum gain is $390 ($130- $125= $5; 5- $1.10 = $3.90). This represents $390 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $110 to open this trade.
That is a potential gain of about 254% 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 GSHD 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.