Pinterest Could Deliver a Triple Digit Gain
Trade summary: A bull call spread in Pinterest, Inc. (NYSE: PINS) using the August $35 call option which can be bought for about $2 and the August $40 call could be sold for about $0.72. This trade would cost $1.28 to open, or $128 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 $128. The maximum gain is $372 per contract. That is a potential gain of about 190% based on the amount risked in the trade.
Now, let’s look at the details.
Bloomberg reported, “Pinterest Inc. surged … after it said revenue in July jumped from a year earlier as advertisers and users returned to the social-sharing service.’
The report continued, “The company estimated year-over-year sales growth of about 50% for this month, through July 29. “We are encouraged by the performance of our business,” it said in a statement on Friday. “But a tremendous amount of uncertainty remains given the ongoing COVID-19 pandemic and other factors.”
For the whole of the third quarter, Pinterest expects sales to grow in the mid-30% range, year over year.
The San Francisco-based company lets users “pin” photos, web links and other content to digital boards with different themes. The app is popular among fans of fashion, home decorating, cooking and other hobbies. During the Covid-19 pandemic, Pinterest has attracted more users, but it has suffered financially as some advertisers cut spending.
On Friday, the company had better news, saying second-quarter advertiser growth accelerated year over year. Spending by small and medium-sized marketers comprised almost half of revenue, thanks to better automated buying tools and momentum overseas.
Revenue came in at about $272 million in the second quarter, up 4% from a year earlier and ahead of Wall Street estimates, according to data compiled by Bloomberg.
“I’m pleased with the way we responded and remained engaged with our advertising partners,” said Chief Financial Officer Todd Morgenfeld. “It has been encouraging to see the recovery in our business over the past few months.”
The company also said it had 416 million monthly active users, up 39% from a year ago and again above analysts’ expectations. Growth was particularly strong in the U.S., driven by existing users returning to the service. However, the company expects slower growth in monthly active users going forward.
“In these tough times, we’re seeing more and more people rely on Pinterest to cook at home, plan kids activities and set up a home office,” Ben Silbermann, chief executive officer of Pinterest, said in a statement. “Businesses are helping them turn their ideas into reality as people are increasingly discovering and buying products on Pinterest.”
PINS is now near its post-IPO high. A breakout could push the stock to the mid $40s.
A Specific Trade for PINS
For PINS, the August 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 August $35 call option can be bought for about $2 and the August $40 call could be sold for about $0.72. This trade would cost $1.28 to open, or $128 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 $128.
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 PINS, the maximum gain is $372 ($40- $35= $5; 5- $1.28 = $3.72). This represents $372 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $128 to open this trade.
That is a potential gain of about 190% 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 PINS 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.
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.