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Luxury Could Be Profitable to Traders

Luxury Could Be Profitable to Traders

Some companies have reputations for being among the best in their industry. That’s the case for Tiffany & Co (NYSE: TIF) which recently announced its latest earnings.

According to Reuters, “Luxury retailer Tiffany & Co said it expected earnings growth to resume in the second half of the year, helped by a healthy e-commerce business, a forecast that allowed investors to look past slightly disappointing quarterly sales.

The New York-based company also stuck to its fiscal 2019 revenue and profit targets, and its shares were up on the news. They fell earlier when investors initially reacted to quarterly sales that narrowly missed Wall Street estimates.

TIF daily chart

Weakening economic growth in China, especially against the backdrop of the trade spat between Beijing and Washington, has been a worry for luxury goods companies that rely on the country’s burgeoning middle class to boost sales.

Two months ago, Tiffany had warned of soft demand in the holiday season because of low spending by Chinese tourists and weakness in Europe and at home.

“We have done a lot, a lot of new things, also things where we had made some mistakes, we are learning, and we are addressing it,” Chief Executive Alessandro Bogliolo said on a post-earnings call, adding he would have “started a holiday campaign three weeks earlier.”

The jeweler has refreshed its collections with more affordable items such as pendants and earrings to appeal to millennials who gravitate to lower-priced competitors such as Denmark’s Pandora A/S and Signet Jewelers.

The retailer said its e-commerce business grew roughly twice the rate of its overall business. Later this year, Tiffany plans to launch an e-commerce enabled website in China to cater to the fast-growing market.

Bogliolo told Reuters he expects the company’s percentage of total sales that are online, currently at 7 percent, to grow.

“I’m really confident that we will reach 10 percent, maybe even 15 percent one day,” he said. “But I don’t see that as a cannibalization of brick-and-mortar.”

Earlier in the year, the company blamed a stronger dollar for weak tourist spending globally during the crucial November-December period.

The company also said it is taking steps to control the volatility surrounding tourist spending by investing in its domestic customers.

For instance, strong marketing campaigns surrounding new and improved product assortments and increasingly digital in-store experiences will help earnings growth resume in the second half of the year, the company said.

The company still expects a decline in per-share profit in the first half of the year due to the external factors Tiffany flagged in the quarter.

The stock appears to have formed a significant bottom late last year.

TIF weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying TIF 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 chart

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 TIF

Every day, we scan the markets looking for trades that TIF 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.

For TIF, the April 18 options allow a trader to gain exposure to the stock.

An April 18 $105 call option can be bought for about $1.90 and the April 18 $110 call could be sold for about $0.48. This trade would cost $1.42 to open, or $142 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 $142.

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 TIF the maximum gain is $3.58 ($110 – $105 = $5; $5 – $1.42 = $3.58). This represents $358 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $142 to open this trade.

That is a potential gain of about 152% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.