Mixed Earnings Could Deliver a 108% Gain
Earnings news can be used to find trades since stocks often drift for weeks after the announcement. As The Street reported, “Oracle Corp (NYSE: ORCL) shares traded lower [recently] after the cloud-focused software group posted mixed second quarter earnings and said it has no plans to hire a co-CEO following the death of Mark Hurd earlier this year.
Oracle said non-GAAP earnings for the three months ending in November, the group’s fiscal second quarter, came in at 90 cents per share, a 12.5% advance from last year and 2 cents ahead of the Street consensus forecast. Group revenues, Oracle said, edged modestly higher to $9.615 billion but fell just shy of analysts’ estimates of a $9.65 billion tally as both license and billings disappointed.
A potentially larger issue for the group’s challenge to larger rivals such as Amazon AMZN and Microsoft MSFT , however, is linked to its leadership plans following Hurd’s passing in October at the age of 62.
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“I remember we announced two CEOs, the first time people thought that was a bit odd. And so now people are finding that we have one CEO is a bit odd,” Oracle chairman Larry Ellison told investors on a conference call late Thursday. “So, let me make it very simple, how is our search going for the news — for a second CEO. We don’t have one. We have no plans for having a second CEO.”
“It was an unusual situation, where Mark and Safra (Catz) were an absolutely fantastic team, but we have complete confidence in our existing management team.” he added.
“We’re doing a lot of recruiting (and) we’re hiring a bunch of people at the next layer down, who are potential CEOs when both Safra and I retire – which is not anytime soon. And so, we’re going to strengthen the management team, but one of the strategies for strengthening that team is not to hire a second CEO.”
Oracle said it sees current-quarter earnings in the region of 95 cents to 97 cents per share, compared to a Street forecast of 97 cents, with revenues in the region of $9.84 billion. The group also said it still expects double-digit EPS growth for the full year.
“Estimate risks looks elevated with the business requiring a step up in the 2H:FY2020 fundamentals to reach its annual revenue acceleration and double-digit EPS growth outlook,” said Oppenheimer analyst Brian Schwartz. “We believe this will be challenging to achieve given a faster license revenue deceleration in F2Q and with a tough y/y comparison looming in F4Q, after a strong performance last year.”
Earlier this fall, Oracle said it plans to open around 20 more cloud data centers by the end of next year, including expansions and job additions in Seattle, San Francisco as well as Asia, Europe and Latin America, adding to the 16 it has already established.
The moves will create another 2,000 jobs, Oracle said, but give the group a stronger foothold in the near $40 billion market for cloud computing and storage.”
The decline comes at resistance and could mark the beginning of a down trend in the stock.
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 ORCL
For ORCL, we could sell a January 17 52.50 call for about $2.42 and buy a January 17 $55 call for about $0.73. This trade generates a credit of $1.69, 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 $169 The credit received when the trade is opened, $169 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $81. 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 ($169).
This trade in ORCL, offers a potential return of about 108% 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 ORCL is below $52.50 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 $81 for this trade in ORCL.