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This Company Has Everything Going For It, Except Profits

This Company Has Everything Going For It, Except Profits

Some companies focus on growth at all costs and expand believing that profits will eventually follow. We saw this in the dot com bubble in the 1990s when companies like Pets.com lost money on each sale but somehow planned to make it up on volume.

It’s possible we are seeing a repeat of that with Spotify Technology SA (NYSE: SPOT). Spotify offers digital music-streaming services.

Users can either select Spotify Free, which includes only shuffle play or Spotify Premium, which encompasses a range of features, such as shuffle play, advertisement free, unlimited skips, listen offline, play any track and high quality audio.

Spotify has a presence in over 20 countries and is soon expanding into India.

Expansion Could Bring More Listeners

According to Bloomberg, Spotify is preparing to introduce its service in India as soon as the first quarter of 2019. Variety previously reported on the agreements, saying Spotify will launch in India within six months.

The expansion provides a major test of Spotify’s ability to lure customers in what it calls the “rest of world” markets — a group that spans from Australia and Japan to Israel and South Africa. The company had about 8 million subscribers in the “rest of world” markets at the end of September.

Though Spotify is the largest paid streaming service globally, it is largely limited to three regions: North America, Latin America and Europe. Those areas, which account for less than a third of the world’s population, contribute more than 90 percent of Spotify’s paying customers.

India is one of the fastest-growing music markets. “It is a high-growth area,” said Vivek Paul, a digital media consultant in Mumbai who used to work at Sony Corp.

But the company could be driven by investor unrest to boost its numbers. Bloomberg noted, “Faster growth in Asia also would help Spotify placate a restless investor base. The company’s stock has dropped about 30 percent since its peak in July — even temporarily slipping below its listing price for the first time.

While much of the decline is due to unease with all technology stocks, investors have been underwhelmed by Spotify’s subscriber growth.”

SPOT daily chart

However, “Spotify’s India campaign has faced some challenges.

As part of a broader dispute that erupted after Spotify began acquiring song rights directly from musicians, some major record labels threatened to withhold rights for India, according to reports at the time.

The streaming service has pushed ahead regardless, making deals with many, though not all, of the largest labels.”

This stock has moved up slightly but now faces resistance and could struggle to move much higher.

SPOT weekly chart

That creates a potential trading opportunity in the stock.

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.

bear call spread

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 SPOT

For SPOT, we could sell a December 21 $136 call for about $7.30 and buy a December 21 $139 call for about $5.70. This trade generates a credit of $1.60, 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 $160. The credit received when the trade is opened, $160 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $140. The risk can be found by subtracting the difference in the strike prices ($300 or $3.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($160).

This trade offers a potential return of about 114% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if SPOT is below $136 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 $140 for this trade in SPOT.

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.