This Retailer Could Deliver a 66% Gain
Making sense of the news can be important to a trader. Let’s start with news, and then look at a trading opportunity that news presents.
“Peloton Interactive Inc. (Nasdaq: PTON) gained almost 10%, hitting a record of $35.23 per share after KeyBanc said the company was seeing strong traffic on Black Friday.”
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Peloton Interactive, Inc. is a provider of interactive fitness platform. The company provides connected, technology-enabled fitness and the streaming of instructor-led boutique classes to its members.
The company operates and manages its business in three reportable segments: connected fitness product segment, subscription segment, and other segment. Its connected fitness product segment consists of its Bike and Tread and related accessories. Its other segment consists of Peloton branded apparels.
Bloomberg continued, “Since Peloton’s initial public offering fell flat two months ago, investors have called for the company to reevaluate its expensive growth ambitions and focus on turning a profit.
The company’s basic “connected fitness” subscription costs $39 a month. Its bikes start at about $2,000 and treadmills start at about $4,000.
SunTrust said on Nov. 5 that an early reading into the company’s marketing promotion of its home trial and its $58 per month bike plan this holiday season “bodes very well” for its second quarter results. Analyst Youssef Squali estimated at the time that Peloton will become profitable sometime in 2022 before achieving full-year profitability the following fiscal year.
The company’s app shares exercise programming with users who don’t own its hardware but pay a monthly subscription fee for the classes, which include yoga, meditation and strength training.
The stock is up about 21% from its IPO price of $29.”
The weekly chart shows the stock did struggle in the days and week’s after trading began. While the IPO did indeed fall flat, as Bloomberg noted, there is now momentum in the stock and that sets up a potential trading opportunity.
Despite recent gains in the stock, analysts do not expect the company to report a profit for the next few years. That means this is a short term trading opportunity rather than a long term trade since the stock is risky in the long run.
A Trade for Short Term Bulls
As with the ownership of any stock, buying PTON 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 has 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.
A Specific Trade for PTON
Every day, we scan the markets looking for trades with 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.
For PTON, the December 20 options allow a trader to gain exposure to the stock.
A December 20 $35 call option can be bought for about $2.75 and the December 20 $37 call could be sold for about $2. This trade would cost $0.75 to open, or $75 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 $75.
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 PTON the maximum gain is $1.25 ($37 – $35= $2; $2 – $0.75 = $1.25). This represents $125 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $75 to open this trade.
That is a potential gain of about 66% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.