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Online Retailer Chewy Could Deliver a 75% Gain

Online Retailer Chewy Could Deliver a 75% Gain

Trade summary: A bull call spread in Chewy, Inc. (NYSE: CHWY) using the May 15 $43 call option which can be bought for about $3.10 and the May 15 $46 call could be sold for about $1.39. This trade would cost $1.71 to open, or $171 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 $171. The maximum gain is $129 per contract.  That is a potential gain of about 75% based on the amount risked in the trade.

Now, let’s look at the details.

It seems likely, according to analysts, that CHWY will report better than expected results in the coming quarter. Yahoo Finance noted, “The deadly and rapidly spreading COVID-19 outbreak has been wreaking havoc on companies around the world. Nevertheless, some companies — including online pet product retailer Chewy — have emerged as winners amid the chaos.”

CHWY has reached new highs, one of the few winners in the current stock market.

CHWY daily chart

Yahoo continued, with comments from the company’s management, “While 2019 closed on a high note, and 2020 got off to a strong start, the world changed dramatically with the coronavirus outbreak,” CEO Sumit Singh said in the company’s earnings statement.

“We are seeing 13.5 million of our active customers engage with us and making sure that we are delivering their essentials and supplies,” Singh said in an interview Friday on Yahoo Finance. “We are seeing a meaningful lift in new customers migrating to our platform as social distancing is practiced more and more.”

Surge in demand has its challenges, according to Singh. “In terms of the shipping delays, yes, we are experiencing a lengthened delivery time. We are acknowledging that on our website. We believe that being transparent with customers during this time is an important thing to do, again going back to communication. And we are also, finding that customer sentiment towards our brand remains motive and customers are understanding and forgiving during this time.”

Here were the main numbers for Chewy’s fourth quarter, compared to Bloomberg estimates:

  • EBITDA loss:$5.85 million vs. $17.8 million expected
  • loss per share:15 cents vs. 10 cents
  • Net sales:$1.35 billion vs. $1.38 billion expected

Chewy expects first-quarter net sales between $1.5 billion to $1.52 billion, exceeding analysts’ expectations for $1.44 billion.

According to a couple key data findings, Chewy’s momentum will likely continue into the first quarter. Bank of America gathered aggregated credit and debit card spend at pet retailers through March 24. The monthly data for January showed year-over-year growth of 6.5% and 9.8% growth in February.

“We note a significant acceleration in March, with data showing y/y daily spending growth averaging 21% through 3/24 and peaking at 58% on 3/16. We note pet retailer strength trending stronger matches recent BAC credit/debit card data showing strength in staples like grocery,” the firm wrote in a note Wednesday.

In addition, alternative data firm Thinknum found that the number of people talking about Chewy on Facebook increased significantly in recent weeks.

“What’s notable is – similar to other brands likely outperforming through the pandemic – Chewy’s Talking About Count kept rising last month, a signal it was on consumers’ minds as they were cooped up at home,” Thinknum Finance Editor Jon Marino wrote.

CHWY has been volatile since its initial public offering last year.

CHWY weekly chart

Breaking out to new highs is bullish, but risk remains high in the current maret

A Specific Trade For CHWY

For CHWY, the May 15 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.

A May 15 $43 call option can be bought for about $3.10 and the May 15 $46 call could be sold for about $1.39. This trade would cost $1.71 to open, or $171 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 $171.

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 CHWY the maximum gain is $1.29 ($46- $43= $3; 3 – $1.71 = $1.29). This represents $129 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $171 to open this trade.

That is a potential gain of about 75% 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 CHWY 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 CHWY 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.

bull call spread

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.