This Could Be a Safer Way to Trade Tech
Tech is a high risk sector. That’s because it is a competitive sector. It’s the kind of business where supermodel Heidi Klum’s warning applies. As she said often on her Project Runway show, “one day you’re in and one day you’re out.”
The possibility of being out one day creates some of the risk in tech. But there are different levels of risk. Some companies have a lower level of risk than others, among them is Tech Data Corp (Nasdaq: TECD).
Tech Data Corporation is a wholesale distributor of technology products. The company serves as a link in the technology supply chain by bringing products from the technology vendors to market, as well as providing its customers with logistics capabilities and services.
It operates through the segment of distributing technology products, logistics management and other value-added services and sells its products to customers in approximately 100 countries throughout North America, South America, Europe, the Middle East and Africa.
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Earnings Boost the Stock
In a recent announcement, PR Newswire reported,
“Net sales were $9.3 billion, an increase of 11 percent compared to the prior-year quarter. On a constant currency basis, net sales increased 12 percent.
Gross profit was $556.6 million, an increase of $30.5 million, or 6 percent. As a percentage of net sales, gross profit was 5.96 percent compared to 6.23 percent in the prior-year quarter.
Net income was $114.2 million, compared to $37.3 million in the prior-year quarter. Non-GAAP net income was $116.3 million, an increase of $39.6 million, or 52 percent.
Included in net income and non-GAAP net income is an $18 million (net of tax) benefit from the collection of a previously reserved accounts receivable.
Earnings per share on a diluted basis (“EPS”) were $2.96 compared to $0.97 in the prior year quarter. Non-GAAP EPS were $3.02, an increase of $1.02, or 51 percent compared to the prior-year quarter.
Included in earnings per share and non-GAAP earnings per share is a $0.47 benefit from the collection of a previously reserved accounts receivable.
Net cash generated by operations during the quarter was $155 million.
Rich Hume, chief executive officer, said:
“I am pleased to report that our teams delivered a strong Q3 performance with great execution across our three regions. Worldwide sales grew 11 percent and we achieved high double-digit non-GAAP operating income and earnings per share growth.
In addition, we generated $155 million in cash from operations, earned an adjusted return on invested capital of 12 percent, paid down $100 million of debt and returned $44 million to our shareholders through share repurchases.
Our Q3 results reflect the powerful combination of our end-to-end portfolio and strong execution by our global teams. They also validate the strategic role we play in the IT Supply chain – delivering high value through our end-to-end portfolio to channel partners across the broad spectrum of IT products and solutions.”
Traders seemed to agree and pushed the stock up.
The jump could be the break of a long term down trend in the stock.
A Trade for Short Term Bulls
As with the ownership of any stock, buying TECD 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.
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 prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for TECD
For TECD, the December 21 options allow a trader to gain exposure to the stock.
A December 21 $90 call option can be bought for about $1.85 and the December 21 $95 call could be sold for about $0.70. This trade would cost $1.15 to open, or $115 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 $115.
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 TECD the maximum gain is $3.85 ($95 – $90 = $5.00; $5.00 – $1.15 = $3.85). This represents $385 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $115 to open this trade.
That is a potential gain of about 334% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.