Risk of $70 Could Lead to an 80% Gain
Trade summary: A bull call spread in Teradata Corporation (NYSE: TDC) using the August $25 call option which can be bought for about $1.30 and the August $27.50 call could be sold for about $0.60. This trade would cost $0.70 to open, or $70 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 $70. The maximum gain is $180 per contract. That is a potential gain of about 157% based on the amount risked in the trade.
Now, let’s look at the details.
Business Wire reported that TDC announced its second-quarter 2020 financial results, noting “The company successfully navigated through an uncertain macro environment to exceed its targets, despite business trends impacted by the ongoing COVID-19 pandemic.”
The stock jumped on the news.
Teradata Corporation is a hybrid cloud analytics software provider. It is focused on delivering data intelligence to its customers. It provides Teradata Vantage, which is an analytics platform. It connects multiple sources of data for ecosystem simplification and delivers scale and integration.
Teradata Vantage incorporates commercial and open source technologies, including its integrated data warehouse engine, and it is available on-premises or in the cloud. Its solutions and services comprise software, hardware, and related business consulting and support services.
“Teradata reported 2020 second-quarter net loss of $43 million under U.S. Generally Accepted Accounting Principles (GAAP), or $0.40 per share, which compared to a net loss of $1 million, or $0.01 per share, in the second quarter of 2019.
On a non-GAAP basis, which excludes stock-based compensation expense and other special items, 2020 second-quarter net income was $26 million, or $0.24 per diluted share, as compared to $34 million, or $0.29 per diluted share in the second quarter of 2019.
Steve McMillan, President and CEO, Teradata said, “Teradata executed well in the quarter, exceeding expectations for our key metrics and delivering robust ARR growth, strong recurring revenue growth, significant free cash flow, and solid earnings per share, despite the uncertainties posed by the COVID-19 pandemic.
The Teradata team demonstrated great resiliency and pivoted quickly and smoothly to support our customers and advance our business, regardless of physical constraints.
Our strong relationships with our stable customer base, combined with our deeply rooted dedication to delivering outstanding business value, are serving us well during these unprecedented times.
As we accelerate our cloud efforts, we are listening to the market and our customers, responding with speed and agility, and ensuring we are providing value for our customers, supporting our people and delivering on our expectations.”
For the third quarter of 2020, Teradata expects recurring revenue between $359 million and $361 million.
GAAP loss / earnings per share in the third quarter of 2020 is expected to be in the range of $(0.03) and $0.00. Non-GAAP earnings per share, excluding stock-based compensation expense and other special items, in the third quarter is expected to be in the $0.28 to $0.31 range.
The long-term chart shows that TDC is bouncing from a months-long base and could challenge resistance near $30.
A Specific Trade for TDC
For TDC, 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 $25 call option can be bought for about $1.30 and the August $27.50 call could be sold for about $0.60. This trade would cost $0.70 to open, or $70 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 $70.
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 TDC, the maximum gain is $180 ($27.50- $25= $2.50; 2.50- $0.70 = $1.80). This represents $180 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $70 to open this trade.
That is a potential gain of about 157% 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 TDC 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.