This Industry Says It’s Time to Worry, and Here’s a Trade In That Sector
Recreational vehicle sales declined last year. This was the first year over year decline since 2009.
Source: RV Industry Association
This could indicate the industry is in trouble and now could be an ideal time to trade the stocks in the sector.
For example, Thor Industries (NYSE: THO) has traded down since the recreational vehicle manufacturer missed Wall Street’s second-quarter earnings and revenue expectations and warned of challenges for the rest of the year.
The Street summarized the news,
“The Elkhart, Indiana-based company reported adjusted earnings of 65 cents a share, missing analysts’ expectations of $1.11. Thor Industries posted a net loss of $5.4 million or 10 cents a share, reflecting acquisition-related costs totaling $42.1 million, or 75 cents a share. Revenue was $1.29 billion, short of Wall Street’s forecast of $1.62 billion.
Thor said the earnings reflected costs associated with the acquisition of Erwin Hymer Group, which was completed after the end of the quarter. The results also reflected the impact of balancing production with market demand, the company said, as wholesale shipments declined compared with retail sales as dealers continued to sell through existing inventories before placing new orders.
Thor said second-quarter wholesale shipments declined at a double-digit percentage compared with relatively stable retail registrations through the end of December. The excess retail sales over wholesale shipments resulted in reductions in dealer inventory ahead of the early spring retail shows and peak summer selling season. The overall levels of discounts and incentives increased compared with the unusually low levels recorded in the second quarter of fiscal 2018.”
“For the rest of fiscal 2019, we expect to face challenges that may impact our financial results as dealers continue to closely manage inventory to levels that better reflect current retail demand, and their ability to replenish inventory more quickly,” Bob Martin, Thor president and CEO, said in a statement.
The stock was also recently downgraded by Moody’s, which changed the company’s outlook to negative.
“At the same time, Moody’s Investors Service affirmed ratings for Thor Industries, Inc. (“Thor”), including the Ba2 Corporate Family Rating (CFR), the Ba2-PD Probability of Default Rating and the Ba2 senior secured rating.
This will lead to further topline and earnings pressures, a weaker set of credit metrics, and more elevated financial leverage.”
This likely means the stock is unlikely to rally and the chart remains bearish.
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 THO
For THO, we could sell an April 18 $60 call for about $1.75 and buy an April 18 $65 call for about $0.40. This trade generates a credit of $1.35, 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 $135. The credit received when the trade is opened, $135 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $365. 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 ($1.35).
This trade offers a potential return of about 36% 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 THO is below $60 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 $365 for this trade in THO.