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This Earnings Surprise Might Not Be Readily Apparent

This Earnings Surprise Might Not Be Readily Apparent

At first glance, traders tend to consider headline numbers associated with earnings. For example, the question might be “did revenue and earnings rise or fall?” But often there is more to a report as in this example.

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  • GlobeNewswire reported that Pluralsight (Nasdaq: PS), an enterprise technology skills company, recently announced financial results for the fourth quarter and full year ended December 31, 2018.

    “Pluralsight’s fourth quarter capped off a milestone year for the company, highlighted by strong customer additions and 42% revenue growth.

    We achieved our seventh consecutive quarter of greater than 50% growth in B2B billings, while continuing to demonstrate the inherent levers to profitability in our model,” said Aaron Skonnard, co-founder and CEO of Pluralsight.

    Billings for the quarter were $100.6 million, an increase of 42% period over period. The quarter’s billings from business customers were $87.1 million, an increase of 51% period over period.

    Revenue was $67.3 million, an increase of 42% period over period. The gross margin was 76%, compared to 70% in the same three months a year ago. The non-GAAP gross margin was 77%, compared to 75% in the same quarter last year.

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  • The GAAP net loss per share was $0.24. Adjusted pro forma net loss per share was $0.09, compared to $0.53 in the same quarter a year ago.

    Cash provided by operations was $8.4 million for the quarter, compared to cash used in operations of $1.3 million in last year’s fourth quarter. Free cash flow was $5.2 million, compared to negative free cash flow of $3.4 million last year.

    For the full year:

    • Billings were $293.6 million, an increase of 43% year over year. Billings from business customers for 2018 were $248.2 million, an increase of 52% year over year.
    • Revenue was $232.0 million, an increase of 39% year over year.
    • Gross margin was 73%, compared to 70% in 2017. Non-GAAP gross margin for 2018 was 76%, compared to 74% in 2017.
    • GAAP net loss per share for 2018 was $0.65. Adjusted pro forma net loss per share for 2018 was $0.60, compared to $1.34 in 2017.

    Financial Outlook

    For the first three months of 2019, revenue is expected to be in the range of $68.0 million to $68.5 million. The adjusted pro forma net loss per share is expected to be in the range of $0.09 to $0.08, assuming weighted-average shares outstanding of approximately 135 million.

    For the full year, revenue is expected to be in the range of $306 million to $314 million. The adjusted pro forma net loss per share is expected to be in the range of $0.32 to $0.26, assuming weighted-average shares outstanding of approximately 137 million.

    Traders seemed disappointed by the news.

    PS daily chart

    The longer-term chart shows that traders had been buying but resistance could stop the advance.

    PS 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 PS

    For PS, we could sell an April 18 $30 call for about $2.05 and buy an April 18 $35 call for about $0.50. This trade generates a credit of $1.55, 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 $155. The credit received when the trade is opened, $155 in this case, is also the maximum potential profit on the trade.

    The maximum risk on the trade is about $345. 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 ($155).

    This trade offers a potential return of about 45% 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 PS is below $30 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 $345 for this trade in PS.

    For more information on options click here for our free guide, The Ultimate Guide to Options Trading.

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