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This Company Could Forecast Gains In a Widely Followed Sector

This Company Could Forecast Gains In a Widely Followed Sector

Some companies can show a turnaround, or a decline in their sector. Recent earnings news highlights data from one of these bellwethers that could be bullish for the auto industry.

According to ZACKS, “CarMax Inc. (NYSE: KMX) posted net earnings per share of $1.13 in fourth-quarter fiscal 2019 (ended Feb 28, 2019), up 68.7% from 67 cents in the year-ago period. The company’s net earnings increased 57.6% year over year to $192.6 million.”

The stock jumped on the news.

KMX daily chart

Zacks continued, “Net sales and operating revenues in the reported quarter increased 5.7% year over year to $4.32 billion. Total gross profit rose 11.7% year over year to $599.4 million.

During fourth-quarter fiscal 2019, CarMax’s used-vehicle sales rose 5.8% from the prior-year period to $3.6 billion as unit sales increased 5.6% to 180,207 vehicles. The average selling price of used vehicles rose 0.3% from the year-ago quarter to $19,978.

Comparable store used-vehicle unit sales rose 2.8% from the prior-year level. The improved performance reflects improved conversion, partially offset by lower store traffic.

Wholesale vehicle revenues rose 3.1% from a year ago to $543.8 million in the reported quarter. Unit sales increased 3.7% year over year to 102,887 vehicles, courtesy of growth in store base. The average selling price of wholesale vehicles declined 1% from the prior-year quarter to $5,024.

Other sales and revenues increased 14.6% year over year. Moreover, the extended protection plan’s (EPP) revenues rose 19.9% from the year-ago level.

CarMax Auto Finance (“CAF”) reported a year-over-year increase of 2.6% in income to $103.7 million in the quarter under review, reflecting collective effects of a 7.8% rise in average managed receivables and a slightly lower total interest margin percentage.”

Barron’s noted, “CarMax is the largest retailer of used cars in the U.S. and the company sold 748,961 cars during its fiscal year ended February 28.

The U.S. used-car market is more than twice the size of the new-car business. Americans purchased more than 39 million used cars in 2018. And auto dealers disclose same-store sales growth as well as credit metrics, giving investors insights into the health of the U.S. consumer.

So following the used-car market can help investors gain an edge when evaluating new-car makers such as General Motors (GM) as well as automotive-parts suppliers such as Aptiv (APTV).”

This could mark a reversal in KMX as the move pushed the price out of consolidation.

KMX weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying KMX 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.

bull call spread

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 KMX

Every day, we scan the markets looking for trades that KMX 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 KMX, the May 17 options allow a trader to gain exposure to the stock.

A May 17 $72.50 call option can be bought for about $1.25 and the May 17 $75 call could be sold for about $0.60. This trade would cost $0.65 to open, or $65 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 $65.

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 KMX the maximum gain is $1.85 ($75 – $72.50 = $2.50; $2.50 – $0.65 = $1.85). This represents $185 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $65 to open this trade.

That is a potential gain of about 184% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.