This Chinese Gamer Offers a Possible Large Gain
Trade summary: A bull call spread in NetEase, Inc. (Nasdaq: NTES) using the December $95 call option which can be bought for about $3.40 and the December $100 call could be sold for about $1.60. This trade would cost $1.80 to open, or $180 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 $180. The maximum gain is $320 per contract. That is a potential gain of about 177% based on the amount risked in the trade.
Now let’s look at the details.
According to a press release on PR Newswire,
NTES, “one of China’s leading internet and online game services providers, today announced its unaudited financial results for the third quarter ended September 30, 2020.
Net revenues were RMB18.7 billion (US$2.7 billion), an increase of 27.5% compared with the third quarter of 2019.
– Online game services net revenues were RMB13.9 billion (US$2.0 billion), an increase of 20.2% compared with the third quarter of 2019.
– Youdao net revenues were RMB896.0 million (US$132.0 million), an increase of 159.0% compared with the third quarter of 2019.
– Innovative businesses and others net revenues were RMB3.9 billion (US$574.4 million), an increase of 41.6% compared with the third quarter of 2019.
Gross profit was RMB9.9 billion (US$1.5 billion), an increase of 25.6% compared with the third quarter of 2019.
Total operating expenses were RMB7.0 billion (US$1.0 billion), an increase of 54.7% compared with the third quarter of 2019.
Net income from continuing operations attributable to the Company’s shareholders was RMB3.0 billion (US$441.6 million), which includes net exchange losses of RMB1.6 billion (US$231.4 million). Non-GAAP net income from continuing operations attributable to the Company’s shareholders was RMB3.7 billion (US$540.4 million).
Basic net income from continuing operations was US$0.65 per ADS (US$0.13 per share). Non-GAAP basic net income from continuing operations was US$0.80 per ADS (US$0.16 per share).
Third Quarter 2020 and Recent Operational Highlights
- Introduced new titles to the Chinese market including Onmyoji: Yokai Koya, PES Club Manager, King of Huntersand For All Time, and EVE Echoes and MARVEL Duel to overseas markets.
- Extended the popularity of a number of mobile titles that climbed China’s iOS top grossing chart in the past months including Invincible, Onmyojiand Sky.
- Maintained steady performances of flagship PC titles such as Fantasy Westward Journey Online, New Westward Journey Online II and Justice.
- Strengthened NetEase Game’s international presence with strong performances from Knives Out, Life-Afterand Identity V in Japan.
- Further developed a robust pipeline with titles including Unknown Future, Akasha
- Book, Revelationmobile game, Infinite Lagrange, Harry Potter: Magic Awakened, The Lord of the Rings: Rise to War, Nightmare Breaker, Ghost World Chronicle, Diablo® Immortal™ and Pokémon Quest. Several of these titles, including Revelation mobile game, will be released before Chinese New Year.
- Increased net revenues from Youdao’s learning services and products by over 200% year-over-year.
“With strong and steady contributions from our online game services, our total net revenues for the third quarter reached RMB18.7 billion, an increase of 27.5% year-over-year,” said Mr. William Ding, Chief Executive Officer and Director of NetEase.
“The strength of our games business is bolstered by our diverse and growing game portfolio with impressive longevity. Additionally, our robust pipeline of games ready for launch is hugely exciting, and we cannot wait to unveil our game sensations across multiple genres to both domestic and global players in the coming quarters.
“Our other businesses including Youdao, NetEase Cloud Music and Yanxuan are also on track, with promising year-over-year topline growth. As we work to bring even more value to our community and shareholders, we will continue to focus on expanding our sustainable growth prospects for each of our businesses,” Mr. Ding concluded.”
The stock gapped up on the news.
The longer-term chart is bullish and shows that the recent consolidation had come near the 52-week highs. This is a bullish chart but risk should always be considered when trading Chinese stocks.
A Specific Trade for NTES
For NTES, the December options allow a trader to gain exposure to the stock. This trade will be open for about three weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A December $95 call option can be bought for about $3.40 and the December $100 call could be sold for about $1.60. This trade would cost $1.80 to open, or $180 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 $180.
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 NTES, the maximum gain is $320 ($100- $95= $5; 5- $1.80 = $3.20). This represents $320 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $180 to open this trade.
That is a potential gain of about 177% 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 NTES 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.