This Company Could Lead the Stock Market
In the late 1800s, Charles Dow noticed that the railroad stocks lead the stock market. That made sense. When manufacturers needed raw materials, they placed orders with producers who shipped the materials via rail.
Finished products also moved on rails at that time. This boosted business in good times and led to slowdowns when the economy contracted. Dow’s work is still current, more than 120 years later. But instead of looking at railroads we need a more inclusive view for companies that ship raw materials and finished goods.
That more inclusive look includes companies like FedEx (NYSE: FDX).
Signs of Trouble?
Analysts at Barrons recently noted,
“FedEx stock is slumping…after the logistics giant reported fiscal second-quarter earnings.
FedEx struck a cautious tone, which has analysts reining in their price targets.
The fiscal second quarter was strong. FedEx earned $4.03 a share on revenue of $17.8 billion, while analysts were looking for EPS of $3.93 on revenue of$17.62 billion. The company said that higher volumes, increased yields, and lower fuel costs all boosted operating income in the quarter.
However, for 2019, FedEx lowered guidance, saying it now expects EPS of $15.50 to $16.60, down from a previous range of $17.20 and $17.80, and below the $17.33 consensus estimate.
The forecast assumes “moderate” U.S. domestic growth and no further weakening in international economic conditions.
Management said that it will still see benefits from the TNT Express acquisition, but lower-than-expected express package volume, on the back of European weakness, which is expected to continue, and the effects of a 2017 cyberattack, will delay the effects, pushing back the boost to operating income to 2020.
Moreover, FedEx called out tariffs as a source of softness.
“Global trade has slowed in recent months and leading indicators point to ongoing deceleration in global trade near term,” management said, while also noting that it’s implementing cost savings to deal with the issue.
Although the holiday shipping season has been strong, on the conference call, FedEx warned that international revenues at FedEx Express aren’t as robust as expected, due to global economic uncertainty. The company is no longer providing guidance for 2019 revenue growth and operating margin.
BMO Capital Markets’ Fadi Chamoun reiterated an Outperform rating, although he lowered his price target to $245, writing that the downbeat forecast and macro uncertainty means that “a serious recovery in the share price appears unlikely in the short term.”
CFRA’s Jim Corridore reiterated a Buy rating on the stock but cut his price target to $245 from $300, writing that “FedEx is working to cut costs in Europe with a restructuring and severance program and by reduced variable compensation.”
Cowen & Co.’s Helane Becker reiterated an Outperform rating on FedEx, although she lowered her price target to $242 from $280.
Becker isn’t surprised that the shares are under pressure from the disappointing outlook, as Europe and Asia weaken.
“Geopolitical issues are weighing heavily on the company’s operations, and are masking what is turning out to be another solid peak shipping season,” she wrote, adding, “FedEx is taking steps to address the weakness by reducing capacity, cutting costs and raising rates.”
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
A Bear Call Spread in FDX
For FDX, we could sell a January 18 $165 call for about $7.90 and buy a January 18 $170 call for about $4.90. This trade generates a credit of $3.00, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $300. The credit received when the trade is opened, $300 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $200. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($300).
This trade offers a potential return of about 150% of the amount risked for a holding period that is relatively short. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if FDX is below $165 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $200 for this trade in FDX.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.