This Social Media Stock Breakout Could Deliver a 164% Gain
Trade summary: A bull call spread in Snap Inc. (NYSE: SNAP) using the December $45 call option which can be bought for about $3 and the December $50 call could be sold for about $1.63. This trade would cost $1.37 to open, or $137 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 $137. The maximum gain is $363 per contract. That is a potential gain of about 164% based on the amount risked in the trade.
Now, let’s look at the details.
SNAP recently reported its quarterly results and Benzinga reported that the “stock soared to a record high as the social media company smashed revenue estimates along with massive earnings beat.
The company delivered $679 million in revenue, smashing past Wall Street expectations at $555 million. Revenue jumped 52% YoY compared to the same period last year.
The social media company unexpectedly reported an adjusted profit of 1 cent per share, topping Wall Street’s estimate of an adjusted loss of 5 cents. Snap reported daily active users of 249 million, up 18% from the year-ago period, exceeding its projections in the range of 242 million to 244 million as well as analysts’ estimates of 243 million. Net losses fell approximately 12%, from last year’s $227 million to $200 million.
Snap reported its daily active users at 249 million which marks approximately a 4% increase from the 238 million it reported in July and 19% up compared to the 210 million from the same quarter one year ago.
The social media company used the third quarter as an opportunity to interact with brands that were looking to align their marketing efforts with platforms who share their corporate values. In other words, Snap took advantage of StopHateForProfit Facebook ad boycott, under which more than 1,000 advertisers paused their ads on the platform back in July. Although Facebook’s inaction to contain and fight hate speech and misinformation didn’t have any severe consequences on the giant as some brands already returned, Snap used this opportunity to interact with advertisers to show the value of its offering and future prospects.
[Looking ahead,] Snap expects YoY revenue growth in the range between 47% to 50% for the fourth quarter. It expects 257 million DAUs but also an increase in expenses.
While uncertainty has become a new normal when it comes to the global macroeconomy, Snap is pleased with what it achieved and remains highly optimistic about its long-term prospects.
The adoption of augmented reality is happening faster than the company previously anticipated, and it is working hard to capitalize on this opportunity. Delivering unexpected, adjusted profit along with positive user and revenue growth in its third-quarter earnings shows Snap is headed in the right direction.”
Recent price action pushed the stock out of a trading range and indicates further upside is possible.
A Specific Trade for SNAP
For SNAP, the December options allow a trader to gain exposure to the stock. This trade will be open for about eight weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A December $45 call option can be bought for about $3 and the December $50 call could be sold for about $1.63. This trade would cost $1.37 to open, or $137 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 $137.
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 SNAP, the maximum gain is $363 ($50- $45= $5; 5- $1.37 = $3.63). This represents $363 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $137 to open this trade.
That is a potential gain of about 164% 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 SNAP 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 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.