This Completed Deal Could Deliver a 77% Gain
Trade summary: A bull call spread in PVH Corp. (NYSE: PVH) using the April 17 $40 call option which can be bought for about $2.60 and the April 17 $45 call could be sold for about $0.80. 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 77% based on the amount risked in the trade.
Now, let’s look at the details.
While many traders try to anticipate news, it’s possible to benefit after news is released. For example, PVH, one of the world’s largest apparel companies, recently announced that it completed the sale of its Speedo North America business to Pentland Group, parent company of the Speedo brand, for $170 million in cash, subject to a working capital adjustment.
The proceeds from the transaction will further bolster PVH’s core balance sheet strength and add to its liquidity position that stands now at over $1.3 billion in cash and available borrowings.
“The decision to reunite the Speedo business globally allows for the brand’s stewardship by Pentland to be holistic and comprehensive,” said Manny Chirico, Chairman and CEO, PVH Corp.
“This transaction aligns with PVH’s goals of optimizing our Heritage Brands business in the ever-evolving retail environment and focusing on long-term growth of our global brands CALVIN KLEIN and TOMMY HILFIGER.”
This sale was previously announced in January.
PVH Corp. is an apparel company. The Company operates through three segments: Calvin Klein, which consists of the Calvin Klein North America and Calvin Klein International segments; Tommy Hilfiger, which consists of the Tommy Hilfiger North America and Tommy Hilfiger International segments, and Heritage Brands, which consists of the Heritage Brands Wholesale and Heritage Brands Retail segments.
The Company’s brand portfolio consists of various brand names, including Calvin Klein, Tommy Hilfiger, Van Heusen, IZOD, ARROW, Warner’s, Olga and Eagle, which are owned, and Geoffrey Beene, Kenneth Cole New York, Kenneth Cole Reaction, Sean John, MICHAEL Michael Kors, Michael Kors Collection and Chaps, which are licensed, as well as various other licensed and private label brands.
The Company designs and markets dress shirts, neckwear, sportswear, jeanswear, intimate apparel, swim products and handbags, footwear and other related products.
The stock seems to have found support near the current level.
The longer term chart shows that volatility has declined as the stock reached the downside target projected from the recent consolidation.
After reaching its target, there should be little downside risk. Using a spread strategy helps to limit risks even more.
A Specific Trade for PVH
For PVH, the April 17 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An April 17 $40 call option can be bought for about $2.60 and the April 17 $45 call could be sold for about $0.80. 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 PVH the maximum gain is $3.20 ($45- $40= $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 77% 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 PVH 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 PVH 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.