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The Search Is Over, Lock In a Potential 71% Gain

The Search Is Over, Lock In a Potential 71% Gain

Trade summary: A bear call spread in Smartsheet Inc. (NYSE: SMAR) using September $45 call options for about $3.63 and buy a September $50 call for about $1.55. This trade generates a credit of $2.08, which is the difference in the amount of premium for the call that is sold and the call.

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  • In this trade, the maximum risk is about $292. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($208). This trade offers a potential return of about 71% of the amount risked.

    Now, let’s look at the details.

    Business Wire reported on the company’s most recent earnings report.

    Total revenue was $91.2 million, an increase of 41% year over year. Subscription revenue was $83.6 million, an increase of 43% year over year. Professional services revenue was $7.6 million, an increase of 20% year over year.

    GAAP operating loss was $26.7 million, or 29% of total revenue, compared to GAAP operating loss of $20.9 million, or 32% of total revenue, in the second quarter of fiscal 2020. Non-GAAP operating loss was $7.4 million, or 8% of total revenue, compared to non-GAAP operating loss of $10.8 million, or 17% of total revenue, in the second quarter of fiscal 2020.

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  • GAAP net loss was $26.6 million, compared to GAAP net loss of $19.1 million in the second quarter of fiscal 2020. GAAP net loss per share was $0.22, compared to GAAP net loss per share of $0.17 in the second quarter of fiscal 2020. Non-GAAP net loss was $7.2 million, compared to non-GAAP net loss of $9.0 million in the second quarter of fiscal 2020.

    Non-GAAP net loss per share was $0.06, compared to non-GAAP net loss per share of $0.08 in the second quarter of fiscal 2020.

    Net operating cash flow was negative $1.3 million, compared to net operating cash flow of negative $2.7 million in the second quarter of fiscal 2020.

    Net free cash flow was negative $4.4 million, compared to negative $7.3 million in the second quarter of fiscal 2020.

    The President and CEO of Smartsheet noted, “These results are a reflection of the stabilization we are seeing in the marketplace. We’re confident in the value of our offerings, the investments we’re making in our future, and our growing opportunity to help enterprises adapt to a reality that demands rapid transformation.”

    Business highlights for quarter include an increase in the number of all customers with annualized contract values (“ACV”) of $5,000 or more grew to 10,049, an increase of 31% year over year

    The number of all customers with ACV of $50,000 or more grew to 1,131, an increase of 78% year over year

    The number of all customers with ACV of $100,000 or more grew to 433, an increase of 92% year over year

    Average ACV per domain-based customer increased to $4,156, an increase of 40% year over year

    Dollar-based net retention rate was 128%

    While news sounds generally bullish for  SMAR, traders sold, and the stock dropped from recent highs.

    SMAR daily chart

    Source: Symbolik

    The weekly chart shows the entire trading history of the stock. It’s possible profit taking will lead to further declines.

    SMAR weekly chart

    Source: Symbolik

    Shorting shares of the stock exposes traders to significant risks in dollar terms. A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.

    A Specific Trade for SMAR

    For SMAR, we could sell a September $45 call for about $3.63 and buy a September $50 call for about $1.55. This trade generates a credit of $2.08, 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 $208. The credit received when the trade is opened, $208 in this case, is also the maximum potential profit on the trade.

    The maximum risk on the trade is about $292. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($208).

    This trade offers a potential return of about 71% 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 SMAR is below $45 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 $292 for this trade in SMAR.

    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.

    bear call spread

    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.

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