This Big-Ticket Item Could Yield Big Gains
A program valued at more than $800 million could power this stock to new short term highs. Zacks recently reported,
“Lockheed Martin Corp.’s (NYSE: LMT) business division, Aeronautics, recently clinched a modification contract for production and delivery of 14 F-35A aircraft from the 15th lot. The deal has been awarded by the Naval Air Systems Command, Patuxent River, Maryland.
Valued at $831 million, the contract is expected to be completed by March 2023. Per the terms of the deal, the company will also offer associated red gear to support the Government of Australia. Majority of the task will be carried out in Fort Worth, TX.
With increased cross-border tensions gripping varied nations across the globe, both developed and developing nations have been ramping up their defense arsenal over the past decade. Notably, military jets comprise major part of the weapon portfolio. Currently, Lockheed Martin’s supersonic, multi-role fighter jet, F-35, is being used by the defense forces of the United States and 11 other nations.
According to Forecast International, a total of 3,401 fighter aircraft are expected to be produced from 2019 through 2028. Notably, the total number of fighters to be produced over the next decade is 17.2% higher than the number of aircraft produced during the previous 10 years. F-35 is anticipated to be the largest fighter program over the next decade.
Of the nearly 3,400 fighters expected to enter the production lines during the next 10 years, 1,548 jets are projected to be F-35s, representing 45.5% of the market. This clearly highlights the importance of the F-35 program in the global fighter jet market.
The F-35 is Lockheed Martin’s largest program that generates more than 25% of its total sales. Last year, the program fueled annual revenue growth by 19.6% at the company’s Aeronautics division. Keeping up with this trend, we may expect the latest contract win to help the Aeronautics unit deliver similar or even better performance in the upcoming quarters.
Taking into account the F-35 program’s solid estimated production rate, as mentioned above, the latest contract win should further provide a boost to this program in the coming days.
Such developments reflect solid prospects for Lockheed Martin’s F-35 program, which are likely to boost the company’s profit margin.”
The short-term chart shows the stock is near new highs.
The long-term chart shows a long term up trend.
A Trade for Short Term Bulls
As with the ownership of any stock, buying LMT 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 has 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.
A Specific Trade for LMT
Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For LMT, the December 20 options allow a trader to gain exposure to the stock.
A December 20 $392.50 call option can be bought for about $5.10 and the December 20 $395 call could be sold for about $3.80. This trade would cost $1.30 to open, or $130 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 $130.
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 LMT the maximum gain is $1.20 ($395 – $392.50= $2.50; $2.50 – $1.30 = $1.20). This represents $120 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $130 to open this trade.
That is a potential gain of about 92% in LMT, based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.