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Large Cap, Boring Company Could Deliver a 122% Gain

Large Cap, Boring Company Could Deliver a 122% Gain

Trade summary: A bull call spread in Deere & Company (NYSE: DE) using the September $200 call option which can be bought for about $7.50 and the September $210 call could be sold for about $3. This trade would cost $4.50 to open, or $450 since each contract covers 100 shares of stock.

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  • In this trade, the maximum loss would be equal to the amount spent to open the trade, or $450. The maximum gain is $550 per contract. That is a potential gain of about 122% based on the amount risked in the trade.

    Now, let’s look at the details.

    DE announced better than expected earnings and increased its outlook for the full year. Traders seemed to like the news.

    DE daily chart

    The Street provided more details, “Deere said adjusted earnings for the three months ending on August 2 were pegged at $2.57 per share, down 8.5% from the same period last year but firmly ahead of the Street consensus forecast of $1.25 per share.

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  • Group revenues, Deere said, fell 11% from last year to $8.925 billion, again besting analysts’ forecasts of a $6.703 billion tally.

    Looking into the end of the 2020 fiscal year, Deer said it sees worldwide agriculture and turf equipment sales falling 10% from last year’s levels, a more positive forecast than it issued following second quarter earnings in May.

    Construction and forestry equipment sales, Deere said, are likely to fall 25%, but again that’s a much better reading than the 40% slump forecast in the spring.

    Overall net income, Deere said, is likely to come in at $2.25 billion compared to a May forecast of between $1.6 billion and $2 billion.

    “As we manage through the pandemic, Deere’s number-one priority continues to be safeguarding the health and well-being of its employees,” said CEO John May.

    “Thanks to aggressive measures taken early in the crisis, we have had success keeping our employees safe, our factories and parts centers functioning, and our customers served.”

    “Although unsettled market conditions and related customer uncertainty are expected to have a moderating effect on key markets in the near term, we believe Deere is well-positioned to help make our customers more profitable and sustainable,” May added.

    “In addition, we are encouraged by the early benefits we are experiencing from the company’s recently launched smart-industrial operating model. We’re confident it will help accelerate our ability to deliver differentiated solutions to our customers, while contributing to improved efficiencies across the company.”

    DE is now at all time highs and could move substantially higher. The price target based on the recent consolation is at least $205.

    DE weekly chart

    A Specific Trade for DE

    For DE, the September 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 September $200 call option can be bought for about $7.50 and the September $210 call could be sold for about $3. This trade would cost $4.50 to open, or $450 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 $450.

    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 DE, the maximum gain is $550 ($210- $200= $10; 10- $4.50 = $5.50). This represents $550 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $450 to open this trade.

    That is a potential gain of about 122% 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 DE 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 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.

    bull call spread

    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.

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