Lyft’s Problems Could Deliver High Income to Traders
Trade summary: A bear call spread in Lyft, Inc. (Nasdaq: LYFT) using September $25 call options for about $3.20 and buy a September $27.50 call for about $1.76. This trade generates a credit of $1.44, which is the difference in the amount of premium for the call that is sold and the call.
In this trade, the maximum risk is about $106. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($144). This trade offers a potential return of about 35% of the amount risked.
Now, let’s look at the details.
Lyft might be forced to shut down in California, one of its most important markets. As the Verge explained, “No Uber and Lyft rides in California? After a judge rejected the companies’ effort to delay an order that they classify drivers as employees, it seems inevitable.
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Uber and Lyft have until August 20th to comply with the order. But the companies have said they will need to go dark in the Golden State in order to retool their business.”
The legal dispute has a long history, as NBC noted, “Since California’s updated labor law took effect at the beginning of 2020, clarifying what defines an employee following a 2018 California Supreme Court decision, companies operating in the gig economy have refused to comply and taken the matter to court.
[The recent court] ruling is the latest attempt to force these companies to follow state law. In his ruling, [the judge] wrote of Uber and Lyft, “It is high time that they face up to their responsibilities to their workers and to the public.”
He rejected the argument that Uber and Lyft are simply technology companies, asserting “drivers are central, not tangential, to Uber and Lyft’s entire ride-hailing business.”
Voters will have their say on the matter soon. A ballot initiative will ask voters to decide if independent contractor status will be permitted in the state. Until then, shares of LYFT are likely to remain under pressure.
Adding to the pressure, as Benzinga reported is a recent earnings announcement.
“Lyft reported a 61% drop in revenue to $339 million as the company suffered from a 60% decline in active riders and a 2% drop in revenue per active rider. EBITDA loss of $280.3 million was narrower than the $295 million loss expected.
Management did note a 78% improvement in monthly rideshare rides in July versus April.
Q2 Rideshare Trends: Lyft’s management commented on rideshare trends, noting a 75% year-over-year decline in rides in April, down 70% in May, down 61% in June, and down 54% in July, Devitt wrote in a note. Meanwhile, August rides through the week ending on the 9th were down 53%.
Lyft’s third-quarter revenue will more closely track rides compared to the second quarter as management invests in driver supply incentives as the company struggled from the demand for rides outpacing the availability of drivers.”
The stock was down on the news.
Shares have been under pressure since the initial public offering last summer.
Shorting shares of the stock exposes traders to significant risks in dollar terms. A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.
A Specific Trade for LYFT
For LYFT, we could sell a September $25 call for about $3.20 and buy a September $27.50 call for about $1.76. This trade generates a credit of $1.44, 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 $144. The credit received when the trade is opened, $144 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $106. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($144).
This trade offers a potential return of about 35% 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 LYFT is below $25 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 $106 for this trade in LYFT.
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.