This Breakout Could Signal a Triple-Digit Gain
Trade summary: A bull call spread in Workday, Inc. (Nasdaq: WDAY) using the September $230 call option which can be bought for about $10.20 and the September $240 call could be sold for about $6.10. This trade would cost $4.10 to open, or $410 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 $410. The maximum gain is $590 per contract. That is a potential gain of about 143% based on the amount risked in the trade.
Now, let’s look at the details.
WDAY reported earnings that attracted buyers to the stock.
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Details of the announcement were reported by Benzinga.
“Workday reported an adjusted EPS of 84 cents on $1.06 billion in revenue. Both numbers beat consensus analyst estimates of 66 cents and $1.04 billion, respectively. Revenue was up 20% from a year ago.
In addition to the impressive numbers, Workday announced co-president Chano Fernandez will be promoted to co-CEO alongside Aneel Bhusri.”
One analyst highlighted the details of the report, “… expanding operating margins and recovering human capital management are bullish trends for Workday.
“The near doubling of the Q2 operating margin to 24% from 12% last quarter reinforces the longer-term profit potential inherent in cloud software models at multi-billion scale,” [the analyst] wrote in a note.
An analyst with Needham said “Workday’s subscription backlog, its revenue growth and its operating margins all exceeded expectations.
“We were most impressed with the reported nine new Global 2000 HCM wins and two FINs wins, which includes a 4k employee federal agency which suggests the government vertical is becoming an attractive opportunity heading into 2H21 and FY22.”
At Credit Suisse analyst was impressed with the speed of the company’s recent progress.
“While macro uncertainties haven’t completely dissipated, we think this quarter certainly weakens the bear thesis around Workday selling longer-term ROI projects that will be deprioritized in the current environment.”
Revenue Reacceleration? Morgan Stanley analyst Keith Weiss said Workday had a strong quarter, but it has an even brighter future.
Buyers pushed the stock above resistance. The pattern now points to a potential price target near $300.
Price targets based on fundamentals, according to analyst reports range from a low of $215 to a high of $295. In reports from five major brokerage firms, three have buy or overweight ratings while two are neutral on the stock.
This all highlights the significant risks that are in the stock. A pullback of the recent breakout could lead to a loss of 10% or more, an amount that is over $2,400 for 100 shares of the stock and an amount that is not insignificant to many investors.
A strategy that manages risk could be best for many individual investors with limited resources.
A Specific Trade for WDAY
For WDAY, the September 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 September $230 call option can be bought for about $10.20 and the September $240 call could be sold for about $6.10. This trade would cost $4.10 to open, or $410 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 $410.
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 WDAY, the maximum gain is $590 ($240- $230= $10; 10- $4.10 = $5.90). This represents $590 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $410 to open this trade.
That is a potential gain of about 143% 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 WDAY 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 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.