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This Digital Health Stock Could Provide a 117% Gain

This Digital Health Stock Could Provide a 117% Gain

Trade summary: A bull call spread in ResMed Inc. (NYSE: NYSE: RMD) using the November $190 call option which can be bought for about $7.50 and the November $195 call could be sold for about $5.20. This trade would cost $2.30 to open, or $230 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 $230. The maximum gain is $270 per contract. That is a potential gain of about 117% based on the amount risked in the trade.

Now, let’s look at the details.

ResMed Inc. develops, manufactures, distributes, and markets medical devices and cloud-based software applications that diagnose, treat, and manage respiratory disorders comprising sleep apnea, chronic obstructive pulmonary disease, neuromuscular disease, and other chronic diseases.

The company operates in two segments, Sleep and Respiratory Care, and Software as a Service.

It offers various products and solutions for a range of respiratory disorders, including technologies to be applied in medical and consumer products, ventilation devices, diagnostic products, mask systems for use in the hospital and home, headgear and other accessories, dental devices, portable oxygen concentrators, and cloud-based software informatics solutions to manage patient outcomes, as well as provides customer and business processes.

The company also provides U-Sleep, which enables automated patient coaching through a text, email, or interactive voice phone call; AirView that enables remote monitoring, over-the-air trouble shooting, and changing of device settings; and myAir, a patient engagement application that offers sleep data and a daily score based on their previous night’s data, as well as connectivity module and propeller solutions.

Business Wire carried the report of the company’s latest earnings release. The stock jumped on the news.

RMD daily chart

Highlights of the earnings report include:

  • Revenue increased 10% to $751.9 million; up 9% on a constant currency basis
  • GAAP gross margin of 58.3%; non-GAAP gross margin expanded 30 bps to 59.9%
  • Net operating profit increased 27%; non-GAAP operating profit up 24%
  • GAAP diluted earnings per share of $1.22; non-GAAP diluted earnings per share of $1.27

Commenting on the results, Mick Farrell, ResMed’s CEO said, “Our first quarter results reflect solid performance and positive trends across our business.

During the quarter, we continued to support the global COVID-19 pandemic response, providing ventilators, masks, and circuits to countries in need around the world.

In our core markets of sleep apnea, COPD and asthma, we are encouraged by the sequential improvement in new patient volume, as well as the ongoing strong adoption of our mask and accessories resupply programs.

We have accelerated the launch of digital health solutions to help clinicians remotely diagnose, treat, and manage patients during the pandemic and beyond. Our global team is effectively managing SG&A expenses, while investing in broad-based R&D programs to help accelerate our ResMed 2025 growth strategy: improving 250 million lives in out-of-hospital healthcare in 2025.”

The stock is near new highs and a breakout could push the stock to $250 or more based on the price target provided by the recent consolidation.

RMD weekly chart

A Specific Trade for RMD

For RMD, the November 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.

A November $190 call option can be bought for about $7.50 and the November $195 call could be sold for about $5.20. This trade would cost $2.30 to open, or $230 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 $230.

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 RMD, the maximum gain is $270 ($195- $190= $5; 5- $2.30 = $2.70). This represents $270 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $230 to open this trade.

That is a potential gain of about 117% 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 RMD 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.