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Last Man Standing Could Provide a Gain of More than 200%

Last Man Standing Could Provide a Gain of More than 200%

Last Man Standing Could Provide a Gain of More than 200%

Sometimes, a company can win by merely outlasting its competition. This is not usually the case. This is winning the loser’s game and large companies usually play a winner’s game.

Those terms date back more than 40 years and are first found in a paper by Charles Ellis, an investment consultant. The paper described money management as a game of tennis.

“Just as amateur players tended to win matches not by hitting brilliant winners but by keeping the ball in play and thus capitalizing on opponents’ errors, he noted that successful investment depended on making the fewest mistakes.”

Ellis explained:

Over a period of many years, he observed that tennis was not one game but two. One game of tennis is played by professionals and a very few gifted amateurs; the other is played by all the rest of us.

Although players in both games use the same equipment, dress, rules and scoring, and conform to the same etiquette and customs, the basic natures of their two games are almost entirely different.

After extensive scientific and statistical analysis, Dr. Ramo summed it up this way: Professionals win points; amateurs lose points. Professional tennis players stroke the ball with strong, well aimed shots, through long and often exciting rallies, until one player is able to drive the ball just beyond the reach of his opponent. Errors are seldom made by these splendid players.

Expert tennis is what I call a Winner’s Game because the ultimate outcome is determined by the actions of the winner. Victory is due to winning more points than the opponent wins–not, as we shall see in a moment, simply to getting a higher score than the opponent, but getting that higher score by winning points.

Amateur tennis, Ramo found, is almost entirely different. Brilliant shots, long and exciting rallies, and seemingly miraculous recoveries are few and far between. On the other hand, the ball is fairly often hit into the net or out of bounds, and double faults at service are not uncommon. The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the Opponent, but he gets that higher score because his opponent is losing even more points.

Sometimes, business can win a loser’s game. That appears to be the case for Tempur Sealy International Inc. (NYSE: TPX).

TPX daily chart

A Competitor Pushes the Stock Up

The Street highlighted that TPX jumped after a report from Reuters that rival Mattress Firm is planning to file for bankruptcy soon.

Mattress Firm is the country’s largest mattress retailer with about 3,000 brick-and-mortar locations, though the company has been losing market share in recent years to online competitors.

Tempur Sealy pulled its Tempur-Pedic products from Mattress Firm stores last year.

Mattress Firm recently cited “ineffective brand marketing” as one of its key strategic issues in a public lender update. The company also noted that it was experiencing a shift in supplier relationships and “merchandising decisions that negatively impacted profitability.”

The Wall Street Journal also confirmed that as part of the bankruptcy filing, a group of bondholders of Mattress Firm’s troubled parent company, Steinhoff International Holdings NV, will inject about $300 million in capital into the retailer, the people said.

Steinhoff, a South Africa-based retail conglomerate, has been caught up in an accounting scandal that erupted in December. In July, Steinhoff’s creditors, who hold billions of dollars of the company’s bonds, reached a deal with the company suspending all payments on its debt for three years.

The bedding chain has a problem with overpenetration in certain markets, Steinhoff told its lenders in a presentation last month. Another issue: Tempur Sealy International Inc., a top mattress maker, abandoned Mattress Firm after a dispute over pricing last year.

Just before Steinhoff took over Mattress Firm in 2016, the retailer had gobbled up some of its largest peers, including the owner of Sleepy’s, as well as Sleep Train Inc. The company is still working on converting many of the Sleepy’s and Sleep Train locations to the Mattress Firm banner.

This news could be reversing a down trend in TPX.

TPX weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying TPX 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.

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.

A Specific Trade for TPX

For TPX, the October 19 options allow a trader to gain exposure to the stock.

An October 19 $55 call option can be bought for about $1.37 and the October 19 $57.50 call could be sold for about $0.62. This trade would cost $0.75 to open, or $75 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 $75.

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 TPX the maximum gain is $1.75 ($57.50 – $55 = $2.50; $2.50 – $0.75 = $1.75). This represents $175 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $120 to open this trade.

That is a potential gain of about 233% 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.