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This Decline Could Set Up a Potential Large Gain

This Decline Could Set Up a Potential Large Gain

News can drive a stock price down sharply. Benzinga recently reported, “Box Inc (NYSE: BOX) shares tanked [recently] … after the company reported a second-quarter earnings beat…

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  • Box’s top- and bottom-line numbers were solid, but its operating margins and lack of large deals seemed to disappoint the market.”

    The stock did recover much of the loss.

    BOX daily chart

    Box reported break-even EPS on $172.5 million in revenue, both topping consensus analyst expectations. However, Box’s in-line 2020 sales guidance wasn’t enough for shares to overcome operating margins growth of just 0.3% and a sharp drop in deals over $500,000.

    Several analysts have weighed in on Box shares following the mixed quarter. Here’s a sampling of what they’ve had to say”

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  • Oppenheimer analyst Ittai Kidron said Box’s suites pricing and product positioning is positive, but pressured expansion and retention rates and mixed large deal numbers will likely limit upside.

    “We expect this to keep the shares range-bound until better visibility into improved and sustainable sales execution emerges,” Kidron wrote in a note.

    KeyBanc analyst Rob Owens said Box’s second-quarter numbers were better than expected, but the company has yet to find a cure for its decelerating growth.

    “Despite the apparent strength, overall revenue growth was 16.4% and ST billings growth of 5.5% are relatively modest from a historical perspective,” Owens wrote.

    D.A. Davidson analyst Rishi Jaluria said Box’s impressive headline numbers don’t hide some less-than-stellar underlying metrics.

    “Shares traded down 8% AMC on declining net retention rates, below consensus deferred revenue, and guidance that bracketed consensus, in our view,” Jaluria wrote.

    Morgan Stanley analyst Melissa Franchi said Box’s second quarter was stable, but its fiscal 2020 guidance was a bit soft given the second-quarter beat.

    “Trading at <3x CY20 sales, downside is likely limited, however, growth likely needs to inflect higher for BOX to see upside,” Franchi wrote.

    Raymond James analyst Brian Peterson said Box’s second quarter is an indication the business is trending in the right direction, and the stock likely has limited downside from a valuation perspective.

    “While the quarter benefited from favorable timing of revenue recognition, we’d argue that results look fairly strong relative to the past two quarters, where management provided a below consensus outlook for FY20,” Peterson wrote.

    The sell off could mark a bottom on the stock.

    BOX weekly chart

    A Trade for Short Term Bulls

    As with the ownership of any stock, buying BOX 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.

    bull call spread

    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 BOX

    Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

    When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

    For BOX, the October 18 options allow a trader to gain exposure to the stock.

    An October 18 $14 call option can be bought for about $1.16 and the October 18 $16 call could be sold for about $0.30. This trade would cost $0.86 to open, or $86 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 $86.

    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 BOX the maximum gain is $1.14 ($16 – $14= $2; $2 – $0.86 = $1.14). This represents $114 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $86 to open this trade.

    That is a potential gain of about 132% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

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