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This Down Trend Could Generate More Than 50% In Immediate Income

This Down Trend Could Generate More Than 50% In Immediate Income

While income remains elusive in the current market environment, some news sets up potential high income opportunities. GlobeNewswire recently reported that Sensata Technologies (NYSE: ST), a global industrial technology company and a leading provider of sensors, reported financial results for its first quarter ended March 31, 2019.

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  • Revenue in the first quarter of 2019 was $870.5 million, a decrease of $15.8 million, or 1.8%, from revenue of $886.3 million in the first quarter of 2018. Excluding a 1.2% negative effect from changes in foreign currency exchange rates and a 1.4% decline from the net effect of acquisitions and divestitures, Sensata reported organic revenue growth of 0.8% in the first quarter of 2019.

    Operating income in the first quarter of 2019 declined 3.4%, totaling $142.6 million, or 16.4% of revenue in the first quarter of 2019 compared to $147.7 million, or 16.7% of revenue, in the first quarter of 2018.  Adjusted operating income in the first quarter of 2019 declined 3.2%, totaling $188.6 million, or 21.7% of revenue in the first quarter of 2019 compared to $194.8 million, or 22.0% of revenue, in the first quarter of 2018.

    Net income in the first quarter of 2019 declined 6.0%, totaling $85.1 million, or $0.52 per diluted share, compared to net income of $90.5 million, or $0.52 per diluted share in the first quarter of 2018.

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    Adjusted net income in the first quarter of 2019 declined 5.2%, totaling $139.3 million, or $0.85 per diluted share, compared to adjusted net income of $147.0 million, or $0.85 per diluted share in the first quarter of 2018.

    Changes in foreign currency exchange rates increased Sensata’s adjusted operating margin by 70 basis points, and increased Sensata’s adjusted earnings per share by $0.03 in the first quarter of 2019 compared to the prior year period. The net effect of acquisitions and divestitures reduced Sensata’s adjusted earnings per share by $0.03 in the first quarter of 2019 compared to the prior year period.

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  • “We delivered strong content growth and significantly outgrew our end markets in the first quarter of 2019,” said Martha Sullivan, Chief Executive Officer of Sensata.

    “Our underlying secular growth is being driven by legislative mandates and consumer demand for products that are cleaner, more efficient, and more electrified. Additionally, we advanced our Electrification and Smart & Connected megatrend initiatives, including signing our first customer agreements for our Wireless Battery Management solution and our Wireless Gateway solution for on-road trucks and trailers.

    While our first quarter revenues were above our guidance, we expect production in the automotive and industrial end markets to be incrementally weaker for the remainder of 2019.”

    Sensata repurchased 3.0 million ordinary shares for total consideration of approximately $150 million during the first quarter of 2019. The Company currently has approximately $100 million remaining on its existing authorization to repurchase additional ordinary shares.

    Sensata’s ending cash balance at March 31, 2019 was $649.5 million, compared to $729.8 million as of December 31, 2018. During the three months ended March 31, 2019, Sensata generated operating cash flows of $112.7 million and free cash flow of $71.0 million.

    The daily chart below shows a rally on the news.

    ST daily chart

    However, the longer-term chart shows general weakness.

    ST weekly chart

    A Trading Strategy To Benefit From Weakness

    A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

    In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

    Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

    One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

    Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

    The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

    bear call spread

    Source: The Options Industry Council

    While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

    You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

    Every day, we scan the markets looking for trades that carry 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.

    A Bear Call Spread in ST

    For ST, we could sell a June 21 $45 call for about $2.04 and buy a June 21 $50 call for about $0.30. This trade generates a credit of $1.74, which is the difference in the amount of premium for the call that is sold and the call.

    Remember that each contract covers 100 shares, opening this position results in immediate income of $174. The credit received when the trade is opened, $174 in this case, is also the maximum potential profit on the trade.

    The maximum risk on the trade is about $326. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($174).

    This trade in ST offers a potential return of about 53% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if ST is below $45 when the options expire, a likely event given the stock’s trend.

    Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $326 for this trade in ST.

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