Losing a Partner Can Lead to Losses and Possible Gains for Investors
Reliance on large customers is common for many companies. These relationships can have a significant impact on sales and earnings and the relationships are often positives for both companies, in the long run. But companies change over time and changes can lead to ending some partnerships.
Barrons recently reported on the end of one long standing relationship,
“Avnet (Nasdaq: AVT) shares are trading sharply lower … after the electronics- component distributor disclosed that Texas Instruments has decided to end the relationship between the two companies.
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According to an Avnet filing with the Securities and Exchange Commission, Texas Instruments (ticker: TXN) told Avnet (Nasdaq: AVT) [last week] that “due to the evolution of TI’s strategy, TI plans to end its distribution relationship with the company by December 31, 2020.”
Texas Instruments accounted for 10% of Avnet’s sales in the June 2019 fiscal year.
Avnet said it will continue to pursue opportunities to support its current and future customers, while also reducing operating costs.
“Over the past several years, we have been evolving our distribution network to better align with our strategy to establish closer, more direct relationships with our customers,” Texas Instruments said.
“As we build these direct relationships, we won’t have as much business flowing through the distribution channel and will require fewer distributors.”
Avnet, Inc., a technology solutions company, markets, sells, and distributes electronic components. The company operates through two segments, Electronic Components and Farnell.
The Electronic Components segment markets, sells, and distributes semiconductors, and interconnect, passive, and electromechanical devices; and other integrated components from electronic component manufacturers.
The Farnell segment distributes kits, tools, and electronic and industrial automation components, as well as test and measurement products to engineers and entrepreneurs. “
The longer-term chart can help investors place the recent weakness in context. Over the past few months, AVT has been in a trading range. The news failed to move the stock out of its range.
Avnet is searching for replacement revenue and recently launched an Avnet Super Store on Alibaba Group’s China-focused B2B purchasing and wholesale marketplace, 1688.com, through an alliance with Alibaba Group, one of the world’s largest e-commerce companies.
The companies announced the alliance, which brings together two established sources of technology innovation, on stage today during Alibaba’s Apsara Conference in Hangzhou’s Cloud Town. One of the first products offered through the new Chinese Super Store will be the Alibaba Cloud-enabled Raspberry Pi 3 Model B/B+ computer.
“Through our alliance with Alibaba Cloud, developers in China can accelerate their IoT prototyping on a familiar and versatile platform with built-in cloud connectivity,” said Nishant Nishant, vice president of digital, Avnet.
“By giving them easy access to feature-rich products that integrate hardware and cloud, plus experts in the Avnet ecosystem that can help them overcome the challenges of scaling to production, Chinese developers will be able to take their IoT solutions to market faster than before.”
However, it may take time and the stock could take time to recover.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in AVT
For AVT, we could sell an October 18 $55 call for about $2.60 and buy an October 18 $60 call for about $0.95. This trade generates a credit of $1.65, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $165. The credit received when the trade is opened, $165 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $335. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($165).
This trade in AVT offers a potential return of about 49% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if AVT is below $55 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $335 for this trade in AVT.