SEC Filings Are Valuable to Traders
As the stock market opened on Monday, sitting atop the list of stocks with large losses was Deckers Outdoor Corporation (NYSE: DECK). At the open, there were no news stories in the company’s news feed explaining the move.
It was unusual to see such a large loss and no news because the opening for major market averages had been higher, continuing the move that began Friday. But, well informed traders knew that there must be some news. This was a large move and there is almost always news to explain a large move.
This is one of the ways professional investors differ from individual investors. Professionals have access to news services like Bloomberg and Thompson Reuters. There are free versions of these services but the subscription services carry news first, and subscribers pay more than $70,000 a year to access them.
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Although these services are beyond the reach of many investors, some of their sources are free and readily accessible by any investor.
DECK’s Decline Explained By the SEC
Searching the SEC’s free database revealed the reason for the decline in the stock. The information was in a form 13D filed by an activist hedge fund, Marcato Capital Management.
This form revealed that Marcato had sold all of its shares in Deckers Outdoor. Marcato is an activist hedge fund that had been pushing for changes at Deckers. The fund wanted management to sell some divisions and make other changes to unlock share holder value.
Marcato waged a proxy battle with the management of Deckers. A proxy battle involves nominating candidates for the Board of Directors to run against management’s candidates. If successful, the fund waging the proxy battle gains important influence over the company.
Marcato, however, was unsuccessful in its bid to change the make up of the Board of Directors. Management indicated they would not be selling off divisions or taking other steps the activists proposed and Marcato simply sold its position in the company.
The position provided Marcato with a big win as shares of DECK rallied more than 70% after the company disclosed its stake in the company. However, the hedge fund owned more than 8% of DECK and its decision to exit drove the price of the shares down.
Its decision to exit was not a surprise given the loss of the proxy battle. However, the supply of stock being dumped into the market weighed down prices, even as investors knew the sale was likely.
The stock is unlikely to rebound until its operating performance improves.
A Trading Strategy While Awaiting Better News
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook, a call option should be sold.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that is important to consider is the bear call spread. This trade uses two calls with the same expiration date but different exercise prices. Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received.
A Bear Call Spread in DECK
For DECK, we have a number of options available. Short term options allow us to trade frequently and potentially expand our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell an April 20 $92.50 call for about $3.00 and buy an April 20 $70 call for about $2.30. This trade generates a credit of $0.70, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $70. The credit received when the trade is opened, $70 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $180. The risk is found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($70).
This trade offers a potential return of about 38% of the amount risked for a holding period that is about one month. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if DECK is below $92.50 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $180 for this trade in DECK.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.