Maybe the Bad News Is Priced In
Stock prices have been falling and that is a trend that will, at some point, reverse. The process will occur at different times for different stocks. For some stocks, the price could reflect the bad news investors and analysts were looking for.
That could be the case for Okta (Nasdaq: OKTA).
Okta, Inc., is an independent provider of identity for the enterprise. The Company’s Okta Identity Cloud platform provides identity management solutions that enable customers to secure their users and connect them to technology and applications.
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It also connects enterprises to their customers, employees, contractors, and partners. It allows users to access a range of cloud applications, Websites, mobile applications and service from various devices. Its platform is used by information technology (IT) organizations to secure their enterprise and by developers to build customer-facing Websites and applications.
Okta Identity Cloud consists of a suite of products to manage and secure identities. It offers a range of products, such as Adaptive Multi-Factor Authentication, Universal Directory, Lifecycle Management products, Single Sign-On, application program interface (API) Access Management and Mobility Management.
It’s a relatively young company and is reporting losses some quarters. ZACKS recently reported,
“OKTA came out with a quarterly loss of $0.04 per share versus the Zacks Consensus Estimate of a loss of $0.11. This compares to loss of $0.19 per share a year ago. These figures are adjusted for non-recurring items.
This quarterly report represents an earnings surprise of 63.64%. A quarter ago, it was expected that this cloud identity management company would post a loss of $0.20 per share when it actually produced a loss of $0.15, delivering a surprise of 25%.
Over the last four quarters, the company has surpassed consensus EPS estimates four times.
Okta, which belongs to the Zacks Internet – Software and Services industry, posted revenues of $105.58 million for the quarter ended October 2018, surpassing the Zacks Consensus Estimate by 9.06%. This compares to year-ago revenues of $68.24 million.”
The company has topped consensus revenue estimates four times over the last four quarters.
Looking ahead, the current consensus EPS estimate is -$0.11 on $99.58 million in revenues for the coming quarter and -$0.47 on $374.59 million in revenues for the current fiscal year.
Investors should be mindful of the fact that the outlook for the industry can have a material impact on the performance of the stock as well. In terms of the Zacks Industry Rank, Internet – Software and Services is currently in the bottom 34% of the 250 plus Zacks industries.
That’s potentially bearish because Zacks research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
But, the stock may have reached a bottom.
A Trade for Short Term Bulls
As with the ownership of any stock, buying OKTA 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.
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 OKTA
For OKTA, the January 18 options allow a trader to gain exposure to the stock.
A January 18 $70 call option can be bought for about $3.25 and the January 18 $75 call could be sold for about $1.95. This trade would cost $1.30 to open, or $130 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 $130.
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 OKTA the maximum gain is $3.70 ($75 – $70 = $5.00; $5.00 – $1.30 = $3.70). This represents $370 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $130 to open this trade.
That is a potential gain of about 284% 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.