This Retailer Shows Signs of a Rally
While many stocks struggled last week on growing concerns of a trade war and perhaps even a recession, some seemed immune to these concerns. Among those, as The Street reported, was a retailer known for high quality kitchen products.
Shares of Williams-Sonoma (NYSE: WSM) moved higher after the specialty retailer beat Wall Street’s first-quarter earnings expectations and raised its full year guidance.
According to the report, “[t]he company reported net income of $52.7 million, or 66 cents a share, compared with $45.2 million, or 54 cents a share, a year ago. Adjusted earnings came to 81 cents a share.
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Revenue totaled $1.24 billion, up from $1.2 billion a year ago.
A FactSet survey of 23 analysts called for quarterly earnings of 69 cents a share on sales of $1.2 billion.
The company said it raised its full-year guidance by 5 cents a share and now expects earnings of $4.55 to $4.75 a share on revenue of $5.67 billion to $5.84 billion.
Wall Street is calling for earnings of $4.60 a share and revenue of $5.73 billion.
“We have had a strong start to 2019 with comparable revenue growth of 3.5%, operating margin expansion and significant EPS growth,” Laura Alber, president and CEO, said in statement.
“Customer acquisition and engagement continued to grow as we delivered more compelling and differentiated experiences to our customers. We also reached a significant milestone for our company as we were named, for the first time, to the Fortune 500 largest companies in the U.S.”
During a conference call with analysts, Alber said the company’s Key Rewards loyalty program was “one of our most valuable and fastest-growing assets.”
“Since the launch of this loyalty program two years ago, total membership has grown to 5.5 million,” she said.
The longer-term chart shows the up surge in price could indicate a break out from a consolidation zone that extends back in time for the past few years. The stock had an initial break out last year and has seen increasing volatility, a potential sign of strength now that the news is bullish for the stock.
A Trade for Short Term Bulls
As with the ownership of any stock, buying WSM 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 WSM
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 WSM, the August 16 options allow a trader to gain exposure to the stock.
An August 16 $60 call option can be bought for about $2.65 and the August 16 $62.50 call could be sold for about $1.80. This trade would cost $0.85 to open, or $85 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 $85
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 WSM the maximum gain is $1.65 ($62.50 – $60= $2.50; $2.50 – $0.85 = $1.65). This represents $165 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $85 to open this trade.
That is a potential gain of about 94% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.