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This Defense Contract Sets Up a Possible Gain of 170%

This Defense Contract Sets Up a Possible Gain of 170%

Trade summary: A bull call spread in Huntington Ingalls Industries, Inc. (NYSE: HII) using the October $150 call option which can be bought for about $4.45 and the October $155 call could be sold for about $2.60. This trade would cost $1.85 to open, or $185 since each contract covers 100 shares of stock.

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  • In this trade, the maximum loss would be equal to the amount spent to open the trade, or $185. The maximum gain is $315 per contract. That is a potential gain of about 170% based on the amount risked in the trade.

    Now, let’s look at the details.

    Huntington Ingalls Industries, Inc. is a military shipbuilding company and a provider of professional services to partners in government and industry. HII is America’s largest military shipbuilding company and a provider of professional services to partners in government and industry.

    The company’s business consists of the design, construction, repair and maintenance of nuclear-powered ships and non-nuclear ships for the United States Navy and coastal defense surface ships for the United States Coast Guard, as well as the refueling and overhaul and inactivation of nuclear-powered ships for the United States Navy.

    Its Ingalls segment includes its non-nuclear ship design, construction, repair and maintenance businesses. Its Newport News includes all of its nuclear ship design, construction, overhaul, refueling, and repair and maintenance businesses. Its Technical Solutions segment provides a range of professional services to the governmental, energy, and oil and gas markets.

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  • Recently, GlobeNewswire reported that HII “was awarded a contract by the U.S. Navy to continue providing logistics support products and services to the Naval Expeditionary Logistics Support Group (NAVELSG).

    The stock was little changed on the news.

    HII daily chart

    The five-year task order was awarded through SeaPort NxG and will be performed at Cheatham Annex, in Yorktown, with support from other HII locations in Virginia.

    “For more than a decade, our team has delivered on the mission to ensure the Navy and Joint Forces have the materiel our nation’s globally deployed military personnel need for optimal readiness,” said Garry Schwartz, president of Technical Solutions’ Defense & Federal Solutions business unit.

    “We are committed to this vital operation and look forward to continuing this decade-long partnership with NAVELSG.”

    HII will continue providing asset management, integrated logistics support and specialized services, including overhaul, kitting, equipment and network support. These activities will enhance NAVELSG’s ability to support forward-deployed service members.

    NAVELSG is a vital enabler of Maritime Prepositioning Forces, Joint Logistics Over the Shore operations and maritime forces ashore. NAVELSG provides expeditionary cargo handling services for surface, air and terminal operations, tactical fueling, and ordnance handling/reporting in support of worldwide naval, joint, interagency and combined forces.

    HII is at support and could move significantly higher before encountering significant resistance.

    HII weekly chart

    A Specific Trade for HII

     For HII, the October 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 October $150 call option can be bought for about $4.45 and the October $155 call could be sold for about $2.60. This trade would cost $1.85 to open, or $185 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 $185.

    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 HII, the maximum gain is $315 ($155- $150= $5; 5- $1.85 = $3.15). This represents $315 per contract since each contract covers 100 shares.

    Most brokers will require minimum trading capital equal to the risk on the trade, or $185 to open this trade.

    That is a potential gain of about 170% 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 HII 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 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 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.

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