Small News Could Create Large Gains For Investors
We are always looking for trading opportunities and find that some small news stories can attract our attention to stocks with significant potential. A recent example of news that seems insignificant to many traders was in a recent Business Wire report, “IAA, Inc. (NYSE: IAA), a leading global marketplace connecting vehicle buyers and sellers, announces the relocation of its Jacksonville, Florida, branch. This new location increases the branch’s capacity by approximately 90 percent.”
IAA provides auction solutions for total loss, damaged and low-value vehicles. The Company facilitates the sale of total loss, damaged and low-value vehicles for a range of sellers, including insurance companies, dealerships, rental car companies, fleet lease companies and charitable organizations.
Its solutions provide buyers with the vehicles they need to fulfill their vehicle rebuild requirements, replacement part inventory or scrap demand. The Company operates as Insurance Auto Auctions, Inc. (IAA) in the United States, Impact Auto Auctions Ltd in Canada and HBC Vehicle Services Limited (HBC) in the United Kingdom.
Business Wire continued, “The Jacksonville branch is one of eleven IAA branches in the state of Florida, which is prone to catastrophic weather events.
“This relocation brings additional capacity to support our growth in this region of the Atlantic coast,” said John Kett, Chief Executive Officer and President of IAA. “This investment aligns with our strategy to continue exceeding our customers’ needs by providing a better experience for buying and selling vehicles.”
IAA is a leading global marketplace connecting vehicle buyers and sellers. Leveraging leading-edge technology and focusing on innovation, IAA’s unique multi-channel platform processes approximately 2.5 million total-loss, damaged and low-value vehicles annually.”
The stock was little changed on the news, which is not unexpected. But the news brought the company’s unique business to investors which could lead to research on the company and eventually increased buying pressure for a company that is profitable and has a history of profits since 2014.
IAA is now trading near its post-IPO rally price. The stock’s IPO in August followed a typical pattern of rally, decline and rally. It is on the second rally that many trading opportunities develop.
A Trade for Short Term Bulls
As with the ownership of any stock, buying IAA 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 has 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.
A Specific Trade for IAA
Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For IAA, the January 17 options allow a trader to gain exposure to the stock.
A January 17 $45 call option can be bought for about $2.45 and the January 17 $50 call could be sold for about $0.72. This trade would cost $1.73 to open, or $173 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 $173.
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 IAA the maximum gain is $3.27 ($50 – $45= $5; $5 – $1.73 = $3.27). This represents $327 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $173 to open this trade.
That is a potential gain of about 89% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.