This Industrial Company Could Deliver 200% in the Next Month
Trade summary: A bull call spread in WESCO International, Inc. (NYSE: WCC) using the September $50 call option which can be bought for about $2.53 and the September $55 call could be sold for about $1.28. This trade would cost $1.25 to open, or $125 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 $125. The maximum gain is $375 per contract. That is a potential gain of about 200% based on the amount risked in the trade.
Now, let’s look at the details.
WCC surged after reporting earnings.
Business Wire offered details. The number traders seemed to focus on was the fact that “excluding merger-related costs, adjusted diluted earnings per share of $1.36.”
WESCO International, Inc. is a distributor of products and provider of supply chain management and logistics services used in industrial, construction, utility and commercial, institutional and government (CIG) markets.
The company is a provider of electrical, industrial and communications maintenance, repair and operating (MRO) and original equipment manufacturers (OEM) products, construction materials, and supply chain management and logistics services.
Its product categories include general supplies, wire, cable and conduit, communications and security, electrical distribution and controls, lighting and sustainability, and automation, controls and motors.
In the earnings announcement, John J. Engel, WESCO’s Chairman, President and CEO, commented, “We delivered a strong second quarter where our sales, margin, profit and cash generation results exceeded our expectations.
Business momentum improved through the quarter as we outperformed the market and built an all-time record backlog.
As we have done in prior economic downturns, we aggressively managed our WESCO business and took significant cost reduction and cash management actions, which enabled us to deliver decremental margins of 10% and generate exceptionally strong free cash flow of 248% of adjusted net income.
Anixter also delivered a strong performance to close out the second quarter. I would like to recognize and thank all of our associates for their inspirational dedication, commitment and hard work in effectively managing through this COVID-19 driven crisis.
With this merger, the new WESCO will capitalize on the accelerating secular trends of electrification, increased bandwidth demand driven by higher voice, data, video and mobile usage, and the digitization of our B2B value chain.
We are more bullish than ever in the substantial value creation that this transformational combination will create for our customers, supplier partners, employees, investors, and the communities in which we operate.”
The stock has bounced sharply off its March bottom and is a market leader.
A Specific Trade for WCC
For WCC, the September 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 September $50 call option can be bought for about $2.53 and the September $55 call could be sold for about $1.28. This trade would cost $1.25 to open, or $125 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 $125.
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 WCC, the maximum gain is $375 ($55- $50= $5; 5- $1.25 = $3.75). This represents $375 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $125 to open this trade.
That is a potential gain of about 200% 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 WCC 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 usually 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.
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.