Large Cap Companies Can Make Big Moves
Many traders focus on small cap stocks because there is a higher likelihood of a large gain in a small cap compared to a large cap. While that is true, it doesn’t mean there is no chance of a large gain in a large cap, as Nike (NYSE: NKE) demonstrated after a strong earnings report.
The company reported revenue of $9.8 billion in the most recent quarter. The 13% gain from a year ago was driven by strong growth in international markets and NIKE Direct globally along with a return to growth in North America.
Source: Standard & Poor’s
Earnings per share (EPS) in the quarter increased 15% to $0.69, primarily due to strong revenue growth, gross margin expansion, a lower tax rate and a lower average share count, which were partially offset by higher selling and administrative expense.
Analysts had been expecting EPS of $0.60 and revenue of $9.4 billion. The numbers pushed traders into the stock and the shares jumped 11.1% on the day of the announcement.
Management was pleased with the results. “Our new innovation is winning with consumers, driving significant momentum in our international geographies and a return to growth in North America,” said Mark Parker, Chairman, President and CEO, NIKE, Inc.
He added, “Fueled by a complete digital transformation of our company end-to-end, this year set the foundation for Nike’s next wave of long-term, sustainable growth and profitability.”
Traders were also pleased by the fact that the share count should continue to drop which could also increase the EPS numbers in the future.
The company also announced that its Board of Directors has authorized a new four-year, $15 billion program to repurchase shares of NIKE’s Class B Common Stock. The company anticipates that the current $12 billion share repurchase program will be completed within fiscal 2019, and the new program will commence upon the completion of the current program.
The question now is whether or not NKE will pull back after the large gains. That is, of course, possible, but the stock is unlikely to give back all of its gains since it is a large cap. That is an advantage of large caps relative to small caps since large stocks should have less volatility.
NKE is likely to at least maintain its gains and could even rally more from this current level. That sets up a potential trading opportunity, one that could be entered with relatively low and defined risks.
A Trade for Short Term Bulls
As with the ownership of any stock, buying NKE 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 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.
A Specific Trade for NKE
For NKE, the July 13 options allow a trader to gain exposure to the stock.
A July 13 $81 call option can be bought for about $0.85 and the July 13 $83 call could be sold for about $0.30. This trade would cost $0.55 to open, or $55 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 $55.
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 NKE the maximum gain is $1.45 ($83 – $81 = $2.00; $2.00 – $0.55 = $1.45). This represents $145 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $55 to open this trade.
That is a potential gain of about 163% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.