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Penn National Could Be a Triple Digit Winner

Penn National Could Be a Triple Digit Winner

Trade summary: A bull call spread in Penn National Gaming, Inc. (Nasdaq: PENN) using the July $37 call option which can be bought for about $3.70 and the July $42 call could be sold for about $2.10. This trade would cost $1.60 to open, or $160 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 $1.60. The maximum gain is $340 per contract. That is a potential gain of about 112% based on the amount risked in the trade.

Now, let’s look at the details.

PENN was up on news that casinos were reopening in Las Vegas.

PENN daily chart

Barron’s reported that, “Dozens of casinos in Las Vegas opened for business again … after being closed since March.

Some were so anxious to get the slots spinning again that they started at 12:01 a.m.—the first legally sanctioned minute they could open.

Their success at drawing customers while keeping Covid-19 at bay will be closely watched. The disease spreads easily in crowded enclosed spaces, scientists have warned. Casino operators say their infection protocols—like frequent cleaning and temperature checks of staff—will keep their customers and staff safe.

Most casinos were closed for about 80 days, or roughly one full quarter of financial results. Public companies running Vegas casinos have cut guidance, suspended dividends, and taken other actions to make it through the pandemic.

Their fortunes have been mixed as the reopening begins.

So far, Wall Street has rewarded gambling companies with less Las Vegas exposure—likely because a Vegas trip involves getting on an airplane and many people are avoiding getting on planes.

The top domestic casino operator is Penn National Gaming, whose stock is up 37% in 2020. Penn has casinos in Vegas but also a strong presence in the Southeast, which had already opened some casinos last month. It is also growing online, a factor that appeals to many investors.

Part of PENN’s rise is due to the company’s agreement to acquire a 36% interest in Barstool Sports, Inc., a leading digital sports media company, for approximately $163 million in cash and convertible preferred stock.

Under the agreement, Penn National will be Barstool Sports’ exclusive gaming partner for up to 40 years and have the sole right to utilize the Barstool Sports brand for all of the Company’s online and retail sports betting and iCasino products.

Jay Snowden, President and Chief Executive Officer of Penn National, commented, “This exciting new partnership with Barstool Sports reflects our strategy to continue evolving from the nation’s largest regional gaming operator, with 41 properties in 19 states, to a best-in-class omni-channel provider of retail and online gaming and sports betting entertainment.”

Mr. Snowden continued, “With its leading digital content, well-known brand and deep roots in sports betting, Barstool Sports is the ideal partner for Penn National and will enable us to attract a new, younger demographic, which will nicely complement our existing customer database.

In addition, with 66 million monthly unique visitors, we believe the significant reach of Barstool Sports and loyalty of its audience will lead to meaningful reductions in customer acquisition and promotional costs for our sports betting and online products, significantly enhancing profitability and driving value for our shareholders.”

PENN weekly chart

A Specific Trade for PENN

For PENN, the July 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.

A July 17 $37 call option can be bought for about $3.70 and the July 17 $42 call could be sold for about $2.10. This trade would cost $1.60 to open, or $160 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 $160.

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 PENN, the maximum gain is $3.40 ($42- $37= $5; 5- $1.60 = $3.40). This represents $340 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $160 to open this trade.

That is a potential gain of about 112% 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 PENN 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  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.