Target Has Triple-Digit Potential After An Upgrade
Trade summary: A bull call spread in Target Corporation (NYSE: TGT) using the December $180 call option which can be bought for about $4.30 and the December $185 call could be sold for about $2.35. This trade would cost $1.95 to open, or $195 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 $195. The maximum gain is $305 per contract. That is a potential gain of about 156% based on the amount risked in the trade.
Now, let’s look at the details.
The stock was highlighted in Barron’s, “Target edged higher last week, helped by an upgrade from Argus Research, which argues that rising traffic at the big-box retailer shows it is gaining market share and can keep winning post-pandemic.
Analyst Christopher Graja raised his rating on Target (ticker: TGT) to Buy from Hold, establishing a $205 price target. He highlights the company’s very robust third-quarter results, especially its 4.5% increase in comparable transactions, which he calls “an astoundingly good number that speaks to Target’s growing relevance with shoppers.”
He also likes that Target’s traffic managed to outshine even Walmart’s (WMT) “excellent” third quarter. He notes that Target customers aren’t just shopping more, they are buying products from a wider range of categories. (Barron’s highlighted this phenomenon in August, noting that Target would be a major apparel destination for back-to-school shopping, as consumers consolidate their trips to just a handful of retailers.)
“We believe that winning business at a time when technology and shopping behavior are changing rapidly and a big swath of the retail market is struggling could be a good indicator of future customer loyalty and market share gains,” writes Graja. (Barron’s also argues that the habits consumers are forming now will linger after Covid-19.)
That leads him to raise his fourth-quarter and fiscal 2021 earnings estimates. He writes that Target can deliver five-year annualized growth of 7%, more than double his prior 3% estimate.
Graja acknowledges that the shares are trading near all-time highs, but multiple catalysts suggest there’s more room for upside. Moreover, while he had previously been concerned about the increasing competitive pressures on Target, the company’s third-quarter results “suggest that Target is winning the competition.”
The news comes with stock consolidating recent gains.
This is the latest in a series of rallies and the stock could move higher based on that pattern.
A Specific Trade for TGT
For TGT, the December options allow a trader to gain exposure to the stock. This trade will be open for about three weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A December $180 call option can be bought for about $4.30 and the December $185 call could be sold for about $2.35. This trade would cost $1.95 to open, or $195 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 $195.
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 TGT, the maximum gain is $305 ($185- $180= $5; 5- $1.95 = $3.05). This represents $305 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $195 to open this trade.
That is a potential gain of about 156% 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 TGT 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.