This Tech Stock Could Deliver a Triple Digit Gain
Tech stocks are volatile, and that volatility can provide extraordinary returns. That makes them great for long term investors. But there are also large gains available to short term investors.
In a recent example, the volatility in a tech stock developed after an earnings report. Tech Data Corporation (Nasdaq: TECD) recently posted its fourth quarter fiscal 2019 results. Earnings beat the Zacks Consensus Estimate. But sales failed to meet the consensus estimate. The stock sold off on the news.
ZACKS explained the sell off could “be due to the company’s soft bottom-line view of $1.80-$2.10 per share for first-quarter fiscal 2020 whose midpoint of $1.95 clearly came below the Zacks Consensus Estimate of $2.09.
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The company reported adjusted earnings of $4.55 per share in the reported quarter. The figure not only surpassed the Zacks Consensus Estimate of $4.10 but also increased 30% on a year-over-year basis.
Net sales of $10,464.5 million increased 4% year over year, backed by solid sales performance in the Americas with robust growth in cloud, storage, networking and notebooks. However, the figure lagged the consensus mark of $10,706 million. Net sales rose 8% on a constant-currency (cc) basis.
Net sales from the Americas (41% of global net sales) rose 10% to $4.2 billion. Sales from Europe (56% of global net sales) remained flat at $5.9 billion. Sales from Asia-Pacific (3% of global net sales) increased 8% to $327.7 million.
The company also provided first quarter fiscal 2020 guidance. The company expects sales to be $8.3-$8.6 billion. Management also noted that the results are likely to be affected by unfavorable currency movements. Specifically, currency headwinds could cost the company about $0.07 per share in earnings and reduce sales by an estimated 4%.
The company projects sales growth to be in the low single digits for the full year while adjusted earnings are expected to increase about 10% for fiscal year 2020.”
All of this good news could indicate that the earnings related selling could provide a buying opportunity.
That would mean the stock should bounce off of support which is visible in the weekly chart near the current price.
A Trade for Short Term Bulls
As with the ownership of any stock, buying TECD 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 TECD
Every day, we scan the markets looking for trades that TECD 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 TECD, the April 18 options allow a trader to gain exposure to the stock.
An April 18 $100 call option can be bought for about $4 and the April 18 $105 call could be sold for about $1.65. This trade would cost $2.35 to open, or $235 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 $235.
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 TECD the maximum gain is $2.65 ($105 – $100 = $5; $5 – $2.35 = $2.65). This represents $265 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $235 to open this trade.
That is a potential gain of about 112% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.