This Could Be the Perfect Company for a Slow Economy
A slowing economy presents opportunities for some companies. Among those is Aaron’s (NYSE: AAN), a company that leases furniture and appliances.
Signs Of An Up Turn
ZACKS recently reported, “Aaron’s has been performing well, thanks to its Progressive segment that continues to witness sturdy momentum for quite a long time. Notable improvement at Aaron’s Business division is also bolstering the company’s performance.
As a result, the company reported earnings beat in seven of the trailing 10 quarters, with sales exceeding estimates for the seventh straight quarter.
Aaron’s Progressive segment, which contributed nearly 52.9% to total revenues in the third quarter of 2018, has been significantly driving the company’s results.
The division includes the virtual lease-to-own business. Impressive growth in the number of active doors, invoice volume and a solid customer base are the key catalysts behind the segment’s quarterly performance.
In the last reported quarter, Progressive revenues surged 26.6% year over year. This uptick was backed by 26% rise in invoice volume owing to a 3.8% improvement in active doors and 21.4% growth in invoice volumes per active door.
As of Sep 30, 2018, this division had 808,000 customers, up 19.7% year over year. The segment’s adjusted EBITDA also registered 31.6% growth, with margin expansion of 40 basis points.
Aaron’s impressive performance also led to an upbeat outlook for the segment. For 2018, revenues at the Progressive division are estimated to be $1.99-$2.02 billion, significantly up from $1.57 billion in 2017. EBITDA is estimated to be $217.5-$222.5 million, up from $187.8 million last year.
Solid momentum in the company’s Progressive division is expected to boost Aaron’s top- and bottom-line performance in 2018. Revenues are projected to come in between $3.80 billion and $3.86 billion, up from $3.38 billion recorded last year. Management envisions 2018 earnings of $3.30-$3.45 per share, reflecting a sharp increase from $2.56 earned in 2017.”
All this good news seems to have been the driving force behind a rally in the stock.
The longer term chart shows risks are high but the pattern also suggests that a significant bottom in the stock could be in place.
This could be an ideal time to buy the stock, especially if the risks can be hedged. An options strategy using a spread can accomplish that, allowing traders to benefit from up side potential while strictly limiting down side risks.
A Trade for Short Term Bulls
As with the ownership of any stock, buying AAN 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 priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for AAN
For AAN, the January 18 options allow a trader to gain exposure to the stock.
A January 18 $45 call option can be bought for about $0.90 and the January 18 $47 call could be sold for about $0.40. This trade would cost $0.50 to open, or $50 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 $50.
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 AAN the maximum gain is $1.50 ($47 – $45 = $2.00; $2.00 – $0.50 = $1.50). This represents $150 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $50 to open this trade.
That is a potential gain of about 200% 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.