This Brazilian Fintech Company Could Deliver a 180% Gain
Trade summary: A bull call spread in StoneCo Ltd. (Nasdaq: STNE) using the June $33 call option which can be bought for about $1.60 and the June $37 call could be sold for about $0.55. This trade would cost $1.05 to open, or $105 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 $1.05. The maximum gain is $295 per contract. That is a potential gain of about 180% based on the amount risked in the trade.
Now, let’s look at the details.
Stock markets around the world have generally rebounded in recent weeks but Brazil has faced political conflict, rising crime and been hit by the global pandemic. The result has been a struggling stock market as the chart of iShares MSCI Brazil Capped ETF (NYSE: EWZ) below shows. EWZ provides investors in the US with immediate access to the Brazilian market.
A recent earnings report pushed one Brazilian stock up, as Benzinga reported, “shares of STNE surged, as the Brazilian financial technology company reported earnings for its first quarter ending March.
StoneCo posted a total revenue of $134 million, up 33% from the $100.2 million reported in the same quarter a year ago.
The earnings per share for the quarter stood at 11 cents, slightly lower than the 12 cents EPS posted a year ago.
StoneCo said total payment volume increased 42.1% year-on-year to $7 billion, giving investors a cause for optimism.”
The daily chart of STNE shows that the stock is near the upper edge of the trading range that developed after the market stopped plummeting.
STNE’s management is upbeat as GlobeNewswire reported, the company CEO attributed the strong results to changes that will benefit the company in the long run,
“We’ve implemented cost-management initiatives and a redesign of processes in our Company to increase operational efficiency. We have made tactical adjustments to our business, so we can navigate safely through this crisis with a strong balance sheet and a lean structure and be ready to support small and medium businesses more than ever without compromising our long-term strategy.”
With momentum pointing up and the stock potentially poised to break through resistance, short term traders may find STNE attractive.
A Specific Trade for STNE
For STNE, the June 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 June 19 $33 call option can be bought for about $1.60 and the June 19 $37 call could be sold for about $0.55. This trade would cost $1.05 to open, or $105 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 $105.
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 STNE, the maximum gain is $2.95 ($37- $33= $4; $4-1.05 = $2.95). This represents $295 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $105 to open this trade.
That is a potential gain of about 180% 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 STNE 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.