This Trade Could Gain 187% As the Stock Breaks Out of a Base
News tends to come in stocks when the technical pattern is at an important level. For an example of that, traders can look at a stock where news about the company was recently highlighted by Benzinga.
“World Wrestling Entertainment, Inc. (NYSE: WWE) shares traded higher … after the company announced a new TV deal for its NXT brand to air a two-hour weekly show on Wednesday nights.
Ahead of the official announcement, one analyst said there’s plenty of upside remaining for WWE.
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The Analyst: MKM Partners analyst Eric Handler on Monday reiterated his Buy rating and $110 price target for WWE.
The Thesis: Handler said current Wall Street forecasts don’t include what he estimates as between $50 million and $100 million in additional annual revenue from the NXT TV deal at an EBITDA margin of around 65%.
Although WWE didn’t disclose the financial terms of the deal, Handler estimates the deal could be worth roughly half the $1.9 million per hour Comcast Corporation (NASDAQ: CMCSA) and Fox Corp (NASDAQ: FOX) are paying for “Raw” and “SmackDown.”
NXT is often referred to as the company’s developmental brand — a place where younger wrestlers can train and work on developing their characters before being “called up” to “Raw” or “Smackdown.”
In addition, Handler says WWE has additional opportunities to further monetize the NXT brand, including raising the number of annual NXT pay-per-view events from five to as many as 12.
“We anticipate WWE management could look to further monetize the NXT brand with international TV deals either through pay-TV or free to air networks,” Handler wrote in a note.
Depending on the terms of the deal, Handler said it could be valued at between $5 and $10 per WWE share, especially if Fox was also bidding for the deal.
This news comes as the stock formed what could be a significant bottom pattern after a pull back from recent highs. The pull back could now be complete and the stock could return to its highs near 4100 a share, or even move above that if the analyst is correct.
A Trade for Short Term Bulls
As with the ownership of any stock, buying WWE 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 WWE
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 WWE, the October 18 options allow a trader to gain exposure to the stock.
An October 18 $75 call option can be bought for about $3.31 and the October 18 $80 call could be sold for about $1.57. This trade would cost $1.74 to open, or $174 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 $174.
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 WWE the maximum gain is $3.26 ($80 – $75 = $5; $5 – $1.74 = $3.26). This represents $326 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $174 to open this trade.
That is a potential gain of about 187% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.