One of Last Week’s Few Winners Could Deliver A Gain of 80%
Trade summary: A bull call spread in RealPage, Inc. (Nasdaq: RP) using the April 17 $65 call option which can be bought for about $3 and the April 17 $70 call could be sold for about $1.22. This trade would cost $1.78 to open, or $178 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $178. The maximum gain is $322 per contract. That is a potential gain of about 80% based on the amount risked in the trade.
Now, let’s look at the details.
The biggest news could be the stock’s rally in a week when the S&P fell more than 10%.
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Earnings were better than expected, as Benzinga reported.
“RP reported strong results for the fourth quarter and its guidance indicates an acceleration in organic growth in 2020, according to DA Davidson.
The firm’s analyst, Peter Heckmann, upgraded RealPage from Neutral to Buy while raising the price target from $60 to $66.
RealPage’s guidance for 2020 came in meaningfully ahead of expectations, including an acceleration in organic growth from 9%-10% in 2019 to 10%-12%, Heckmann said in the note.
The company reported fourth-quarter revenue of $255 million, representing 12% growth and beating the consensus estimate. The analyst further noted that adjusted EBITDA margins expanded 310 basis points on a year-on-year basis to 29.9%, despite “an increased focus on solution integration and accelerating complex implementations.”
Adjusted earnings grew 23% to 48 cents per share, also coming in higher than the consensus estimates.
RealPage made the largest acquisition in its history in December, when it took over Buildium, a provider of cloud-based solutions for smaller property managers, for $580 million in cash. Heckmann added that this acquisition significantly expanded the company’s presence in the market for small and medium businesses.
Following management’s guidance, the analyst raised revenue and earnings forecasts for 2020 and 2021.”
At least one other analyst agreed as Dallas Business Journal noted,
“We expected near-term stabilization, but the growth inflection is already arriving,” Joe Vruwink, an analyst with R.W. Baird, said in a research note that raised the company’s stock-price target.
It’s an “attractive time to invest in RealPage as company enters the next chapter of growth opportunity,” he added.
The company is benefitting from growing demand from the real estate market for software as it increasingly embraces technology. RealPage has been investing in acquisitions and products to bolster its lineup for customers.
“The emergence of vertical software companies like RealPage, with solutions exclusively focused on the real estate markets, tailored to the needs of professionals in the industry, and delivered over the internet in a recurring subscription model, is slowly starting to change the way property owners and managers operate,” Vruwink said in the note.
Vruwink pointed to the re-acceleration in organic growth during the first quarter with a guide of 10 percent to 11 percent year over year compared 9 percent in the fourth quarter.”
The stock is now at the upper edge of a trading range and the weekly chart is among the most bullish in the stock market.
A Specific Trade for RP
For RP, the April 17 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An April 17 $65 call option can be bought for about $3 and the April 17 $70 call could be sold for about $1.22. This trade would cost $1.78 to open, or $178 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 $178.
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 RP the maximum gain is $3.22 ($70- $65= $5; $5 – $1.78 = $3.22). This represents $322 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $178 to open this trade.
That is a potential gain of about 80% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying RP 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.