This Bed Maker Could Provide a Good Night’s Sleep and a 112% Gain
Trade summary: A bull call spread in Tempur Sealy International, Inc. (NYSE: TPX) using the July $72.50 call option which can be bought for about $4.20 and the July $77.50 call could be sold for about $2.60. This trade would cost $1.60 to open, or $160 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 $1.60. The maximum gain is $340 per contract. That is a potential gain of about 112% based on the amount risked in the trade.
Now, let’s look at the details.
According to a report on Yahoo Finance, bed makers could be a safe bet in the stock market, “Consumers are saying their sleep has taken a hit amidst COVID-19, so it’s conceivable the sales strength in bedding continues into year end.
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Over half of the nation qualified their sleep as poor or fair in a March survey conducted by The Better Sleep Council. That was up from 43% in January, pre-national quarantine. The same survey showed 24% of Americans woke up feeling rested and refreshed in March, worse than the 30% rate seen in January.”
Another report, this one in PR Newswire provides insight into a sleep trade, “TPX announced [recently] that Sealy was ranked number one on Furniture Today’s list of the Top 20 U.S. Bedding Producers.
Furniture Today estimated that Sealy sales were up 12.5% in 2019 which propelled the brand to reclaim the number one position on the list which was previously held by Sealy for over 40 consecutive years until 2011.
Furniture Today is one of the most respected trade publications in the bedding industry and has compiled the list of top bedding producers annually since the 1970s.
Sealy was started in Sealy, Texas in 1881 and has produced over 100 million mattresses during the last 130 years. Sealy’s exclusive Posturepedic Technology™ was developed with the help of orthopedic specialists to deliver reinforced support and is featured across the Response, Conform and Hybrid lines of products. Sealy mattresses are available around the world and are proudly built in the U.S. for the domestic market.
“It is clear that our multi-year investments in our people, products, service, manufacturing and logistics have driven our exceptional results,” said Scott Thompson, who has been Tempur Sealy Chairman and CEO since 2015.
The stock is bouncing off of potential support.
The longer-term chart shows that TPX has delivered strong performance in the long run. The selloff that affected the broad market drove the stock down and a recovery appears to be underway.
A Specific Trade for TPX
For TPX, the July 19 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.
A July $72.50 call option can be bought for about $4.20 and the July $77.50 call could be sold for about $2.60. This trade would cost $1.60 to open, or $160 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 $160.
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 TPX, the maximum gain is $3.40 ($77.50- $72.50= $5; 5- $1.60 = $3.40). This represents $340 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $160 to open this trade.
That is a potential gain of about 112% 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 TPX 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 usually 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.