Some Earnings Beats Fail to Impress Traders
In earnings season, many traders ignore the actual numbers. They focus more on how the reported results compare to the estimates of Wall Street analysts that follow the company. Often an earnings beat will send a stock higher. Other times, the stock sells off after a bear.
NCR Corp. (NYSE: NCR) recently announced its latest quarterly results and presented an example of the latter. The Associated Press reported,
“NCR, a provider of omni-channel technology solutions for businesses to connect, interact, and transact with their customers worldwide, reported a loss of $47 million in its fourth quarter.
NCR notes that it is a “global leader in consumer transaction technology. For more than 130 years, NCR has helped companies better connect, interact and transact with customers. Improving the customer experience is at the very heart of our vision and mission at NCR.”
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While NCR may not be a household name, its customers certainly are. A recent presentation the company prepared for analysts showed a list of some of the best-known clients.
The Atlanta-based company said it had a loss of 51 cents per share. Earnings, adjusted for one-time gains and costs, came to 84 cents per share.
The results beat Wall Street expectations. The average estimate of five analysts surveyed by Zacks Investment Research was for earnings of 83 cents per share. However, the stock sold off on the news.
The maker of ATMs and other hardware and software to handle payments posted revenue of $1.8 billion in the period, which also topped Street forecasts. Three analysts surveyed by Zacks expected $1.79 billion.
For the year, the company reported a loss of $88 million, or $1.16 per share, swinging to a loss in the period. Revenue was reported as $6.41 billion.
NCR expects full-year earnings in the range of $2.75 to $2.85 per share.”
The reaction to the news could spell the end to the recent rally in the stock and that could result in a resumption of the long term down trend that is well defined in the chart below.
Although It can be difficult to determine the way that traders will react to news in advance, it is possible for short term traders to react to the news with strategies that can deliver profits and limit risks.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
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 traders can consider is the bear call spread. This is a trade that 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. The call is sold to limit the risk of the trade. So this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It 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 and is also known.
Every day, we scan the markets looking for trades that carry 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.
A Bear Call Spread in NCR
For NCR, we could sell an April 18 $27 call for about $1.57 and buy an April 18 $29 call for about $0.80. This trade generates a credit of $0.77, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $77. The credit received when the trade is opened, $77 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $123. The risk can be found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($77).
This trade offers a potential return of about 62% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if NCR is below $27 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 $123 for this trade in NCR.