New Product Momentum and Solid Execution Drive Possible Gains
Sometimes, seemingly boring news releases can point the way to trades that have unusually large potential. A recent release from PR Newswire can be used to illustrate a recent example, using actual market data to explain the potential.
Hill-Rom Holdings, Inc. (NYSE: HRC) jumped after the company reported that new product momentum and solid execution drive an expansion of margins, phrases used to highlight the latest financial results for the fiscal second quarter ended March 31, 2019 along with an and updated its fiscal 2019 financial outlook.
For the fiscal second quarter, the news release said, “Hill-Rom reported worldwide revenue of $714 million and GAAP earnings of $0.74 per diluted share.
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These results reflect the new revenue recognition accounting standard, ASC 606, which the company adopted on a modified retrospective basis beginning in the fiscal first quarter 2019.
On a comparable basis under ASC 606, fiscal second quarter adjusted earnings of $1.14 per diluted share advanced 12 percent over the prior-year period and exceeded the company’s guidance of $1.09 to $1.11 per diluted share.
These results reflect accelerated core revenue growth, continued margin expansion and strategic investments to drive future growth.
“We are pleased to deliver another strong quarter of accelerated core revenue growth, positive new product momentum across our diversified portfolio, and financial results that exceeded our guidance,” said John P. Groetelaars, Hill-Rom’s president and chief executive officer.
“This performance reflects the power of our global brand, strong customer relationships, and increasing demand for our innovative technologies and solutions. We continue to execute on our strategic priorities and vision of advancing connected care to enhance outcomes for patients and their caregivers.”
Worldwide reported revenue of $714 million in the fiscal second quarter increased 1 percent, or 3 percent on a constant currency basis under ASC 606 in both the current and prior periods.
Hill-Rom’s core revenue advanced 6 percent, exceeding the company’s guidance of approximately 4 percent growth. Core revenue excludes foreign currency, divestitures, and non-strategic assets the company may exit, including the Surgical Solutions international OEM business.
The gain that followed the news could mark the end of a pullback in the stock that can be seen on the longer term chart.
A Trade for Short Term Bulls
As with the ownership of any stock, buying HRC 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 HRC
Every day, we scan the markets looking for trades that HRC 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 HRC, the June 21 options allow a trader to gain exposure to the stock.
A June 21 $105 call option can be bought for about $2.50 and the June 21 $110 call could be sold for about $1.05. This trade would cost $1.45 to open, or $145 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 $145
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 HRC the maximum gain is $3.55 ($110 – $105 = $5; $5 – $1.45 = $3.55). This represents $355 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $145 to open this trade.
That is a potential gain of about 144% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.