The Economy Points to Gains in This Stock
Source: Robert Half.com
We often hear that the stock market is an economic indicator. That’s because stock prices are forward looking and economic data is reported with a significant delay. It will take, for example, six to nine months, for GDP reports to reflect what happened in any given quarter.
The relationship indicates that we could be able to forecast some economic trends with stock market data. For example, we could develop an assumption about the direction of changes in GDP by watching the rate of change in the price of major stock market indexes.
The relationship extends the other ways at times. Some economic data is called high frequency data because it is reported weekly. Among the few data series falling into this category is new claims for unemployment insurance. This data series is shown below.
Source: Federal Reserve
Finding a Stock That Tracks the Data
The chart above shows that the number of new claims for unemployment insurance has been in a steady downtrend for the past five years. This indicates that fewer employees are being laid off. That could be because the economy is doing well and firms need employees to meet demand.
No matter what the reason for fewer claims is, the trend is clear and that leads to the conclusion that the pool of potential workers is shrinking as the labor market tightens. This means companies looking to expand and hire new employees face an increasing challenge.
In this environment, the shares of staffing companies like Robert Half International (NYSE: RHI) should fare well.
The company provides staffing and risk consulting services in North America, South America, Europe, Asia, and Australia. It places temporary and permanent personnel for accounting, finance, bookkeeping, administrative personnel, information technology consultants and legal staff among other areas.
The advantage of using RHI is that they screen personnel freeing up a company management’s team to maintain its focus on operations while hiring.
On Wednesday, the stock jumped after reporting better than expected earnings.
RHI has been in an up trend, as expected given the extended trend in lower unemployment in the economy. The company also benefits from improvements in the employment market around the world.
In Europe, for example, although the rate of unemployment remains significantly higher than it is in the United States, the trend is down as the next chart shows.
Source: Federal Reserve
This chart shows the trend over the last five years in the European Union. Rules in many European countries make it difficult to fire employees, so the hiring decision becomes even more critical than it is in the United States.
RHI’s European operations benefit companies by screening candidates and offering temporary employment services to provide a trial period of employment, helping company’s reduce the risks associated with hiring.
These trends are likely to continue and the trend in shares of RHI is also likely to continue. Even as hiring slows, which it eventually will, the labor market will remain tight for some time. This increases the value of a company that is able to sift through the hundreds of resumes a job announcement is likely to attract.
But, in the short run, RHI could consolidate its recent gains. That makes the stock an ideal candidate for a trading strategy designed to benefit from a consolidation with a bullish bias.
Trading the Trend
When a stock is expected to move higher, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.
Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up trend.
Source: The Options Industry Council
This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.
Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.
Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.
A Specific Trade for RHI
For RHI, a bull put spread could be opened with the May 18 put options. This trade can be opened by selling the May 18 $55 put option for about $0.45 and buying the May 18 $50 put for about $0.10.
This trade would result in a credit of $0.35, or $35 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.
The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $5 ($55 – $50). This is multiplied by 100 since each contract covers 100 shares.
Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $465 ($500 – $35).
The potential gain is about 7.4% of the amount of capital risked. This trade will be for about one month and the annualized rate of return provides a significant gain.
The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how to trade options to meet your goals, click here for details on Options Insider.