This Company Proves That Old Adage, “When It Rains, It Pours”
The general nature of news does tend to have a stickiness to it. Examples are available in almost any field. In sports, when a team is on a winning streak we frequently see good news with players performing well individually and as a group.
Likewise, a losing streak might be accompanied by slumps in the performance of individual players and even injuries. It seems at times that good news or bad news occurs in clumps. This is true not only for sports teams but for politicians, companies and even individuals.
This tendency was on display in the earnings announcement of Newell Brands Inc. (NYSE: NWL).
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Tariffs, Customer Bankruptcies, and More Bad News From the Company
Newell has been working to complete a corporate reorganization. Already, the company has completed and planned divestitures.
Newell has completed the sale of The Waddington Group and Rawlings Sporting Goods. Efforts continue to sell Jostens, Goody and U.S. Playing Cards. In some ways, the company is succeeding.
In the most recent quarter, NWL reported earnings per share (EPS) of $0.82 cents, five cents better than expected. But sales of $3.73 billion missed expectations which had been for $3.83 billion. Management indicated EPS for the year should be between $2.45 and $2.65, down $0.20 from earlier guidance.
The stock sold off on the news.
Management also lowered expectations for revenue. The company now expects sales to be between $8.7 billion and $9 billion in 2018, down from its previous guidance of between $14.4 billion and $14.8 billion. This marked the fourth time management lowered guidance in the past year.
According to The Wall Street Journal, Chief Executive Michael Polk said on a call with analysts that Newell faces “an intense period of change” as shoppers move online and major retailers close stores, and that the overhauled company “will be simpler, faster and stronger.”
He said sales in the company’s core units should improve toward the end of the year.
Mr. Polk cited a “huge inventory shift” at office-supply giants that are scrambling to remake themselves as everyday shoppers buy fewer office products and move more of their purchases online. Staples Inc. was acquired last year by a private-equity firm, and Office Depot Inc. installed a new CEO last year and is working to reposition itself as a tech-support provider less dependent on sales of pens and paper.
Other bad news included an unseasonably cool spring that hurt Newell’s outdoor brands such as Coleman and Marmot, executives said.
The company also said Toys “R” Us stores in the U.S. being liquidated led to significant, but not unanticipated, declines in its baby division. Newell said its decline was also because of 2017 divestitures and a new revenue accounting standard.
And, Newell also said its latest guidance includes the $100 million impact due to the U.S. tariffs on China-sourced goods and the retaliatory tariffs by the EU and Canada, with the greatest exposure on baby products, appliances and food.
These problems indicate the long term down trend in the stock is unlikely to reverse soon.
A Trading Strategy To Benefit From Weakness
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook for the short term, a call option should be sold.
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 is important to consider is the bear call spread. This trade 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, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy 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.
A Bear Call Spread in NWL
For NWL, we have a number of options available. Short term options allow us to trade frequently and potentially increase our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell an August 17 $23 call for about $0.60 and buy an August 17 $25 call for about $0.10. This trade generates a credit of $0.50, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $50. The credit received when the trade is opened, $50 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $150. The risk is found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($50).
This trade offers a potential return of about 33% of the amount risked for a holding period that is about two weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if NWL is below $23 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 $150 for this trade in NWL.
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