Square’s New Features Could Explain a Possible 138% Gain
Trade summary: A bull call spread in Square, Inc. (NYSE: SQ) using the October $160 call option which can be bought for about $10.85 and the October $165 call could be sold for about $8.75. This trade would cost $2.10 to open, or $210 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 $210. The maximum gain is $290 per contract. That is a potential gain of about 138% based on the amount risked in the trade.
Now, let’s look at the details.
Square shows an interesting chart pattern. It is potentially forming a cup with saucer bullish pattern.
Stocks with this pattern often have exciting news, which explains a catalyst that could drive a breakout to new highs in the stock. For SQ, Business Wire carried news that could provide a catalyst.
“Square announced the launch of two new features that enable Square Payroll customers and their employees to more easily and effectively manage their cash flow: On-Demand Pay for employees, and Instant Payments for employers.
The new offerings, which leverage Square’s Seller and Cash App ecosystems, represent a major milestone in providing employees and employers more flexibility and control over their money.
“The traditional payroll process is slow and rigid, creating cash flow constraints for employees and businesses alike. This is even more pronounced now given the current economic conditions,” said Caroline Hollis, GM of Square Payroll.
“Because businesses still run payroll on a fixed schedule, employees are paid days or weeks after they’ve worked. We created On-Demand Pay for employees so they can access their earnings when they need them, as soon as their shift has ended.
For employers, it can take up to four days for payroll funds to move from their bank account to their team. With Instant Payments, employers can now fund their payroll instantly, getting money to their team faster.”
There are more than 80 million hourly workers across the country, many of whom regularly face cash flow constraints that are exacerbated by traditional biweekly and monthly pay schedules. …
Now, each pay period, eligible employees using On-Demand Pay can transfer up to $200 of their earned wages whenever they need them, for free to Cash App, Square’s mobile payment service that allows individuals to spend, send, store, and invest money.
Some employees will also have the option to transfer their on-demand pay to a linked debit card for a 1% fee per transfer, not to exceed $2.
There is no change to how or when the employer processes payroll when employees use this feature; instead, Square Payroll automatically adjusts the employee’s earnings when the employer runs their next regularly scheduled payroll.
Eligible employees can access On-Demand Pay directly within the Square Team App after clocking out, or through their shift summary email.
Instant Payments allows Square Payroll customers to fund their payroll using the money in their Square Balance, where sales they process via Square are stored.
By expanding the functionality of an employer’s Square Balance and enabling Sellers to select it as a payment source, Square receives confirmation of payroll funds instantly and can initiate payouts to employees immediately.
Team members and contractors who have elected to be paid via Cash App receive their pay within minutes, while those paid via direct deposit get their pay as soon as the next business day.”
The longer-term chart of SQ shown below confirms that the stock has been consolidating in an up trend and could be positioned for a break out.
A Specific Trade for SQ
For SQ, the October 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 October $160 call option can be bought for about $10.85 and the October $165 call could be sold for about $8.75. This trade would cost $2.10 to open, or $210 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 $210.
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 SQ, the maximum gain is $290 ($165- $160= $5; 5- $2.10 = $2.90). This represents $290 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $210 to open this trade.
That is a potential gain of about 138% 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 SQ 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 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.