This Earnings Report Shows the Economy Isn’t Out of the Woods Yet
While the stock market appears to be recovering from last year’s sell off, economic news continues to deliver mixed results and the economic news, in fact, continues to give room to a pessimistic interpretation. A recent earning report adds to the gloom.
Transportation companies are at the edge of the economy. When they do well, it usually means the economy is expanding. That’s a concern because as The Street reported,
“Shares of XPO Logistics Inc. [fell] after the global freight transportation and warehousing company missed Wall Street’s fourth quarter earnings expectations and warned of a reduction of business for 2019.
The … company reported net income of $84 million, or 62 cents a share, down from $189 million, or $1.42 a share a year ago. Adjusted earnings came to 72 cents a share, missing analysts’ expectations of 84 cents.
Quarterly revenue totaled $4.39 billion, up 4.6% to $4.19 billion from a year ago. Analysts expected $4.56 billion.
For the year, the company reported profit of $422 million, or $2.88 a share, and revenue totaled $17.28 billion.
XPO said the reduction of business from its largest customer cut revenue by $46 million in the fourth quarter. The customer also curtailed business with XPO in early 2019, which could decrease revenue by roughly $600 million this year, or about two-thirds of the revenue the customer generated in 2018.
“We expect that our adjusted EBITDA growth this year will be in the range of 6% to 10%,” Bradley Jacobs, chairman and CEO, said in a statement. “This anticipates the impact of our largest customer substantially downsizing its business portfolio with us starting in the first quarter, as well as our more cautious view of Europe.”
For full year 2019, XPO said it expects revenue growth of 3% to 5%, which corresponds to organic revenue growth of 4% to 6% year over year.
JPMorgan analyst Brian Ossenbeck kept his overweight rating on XPO Logistics stock but trimmed his price target to $78 a share from $84.
Ossenbeck said in a note that “reading between the lines, we believe the shipper that is paring down its parcel injection, brokerage, last mile, and logistics activity with XPO is Amazon.
“Given the e-tailer’s efforts to expand its logistics capabilities,” Ossenbeck wrote, “we expect the market will interpret the XPO contract loss as Amazon taking capacity in-house which is negative for [FedEx] and UPS.”
Separately, XPO Logistics said will close a Memphis warehouse where employees had complained about widespread discrimination and a number of pregnant workers had miscarriages. The moves follow a New York Times investigation of the location.
The company said it would close the site because Verizon, whose cellphones and other products XPO ships from the warehouse, had decided to stop using the facility. More than 400 XPO employees will lose their jobs.
The long-term trend could remain bearish for the stock.
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.
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 XPO
For XPO, we could sell a March 15 $52.50 call for about $1.32 and buy a March 15 $55 call for about $0.55. This trade generates a credit of $0.77, 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 $77. The credit received when the trade is opened, $77 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $173. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($0.77).
This trade offers a potential return of about 44% 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 XPO is below $52.50 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 $160 for this trade in XPO.