• Facebook
  • Twitter
  • Podcast

This Trade in W Could Provide Income of 109%

This Trade in W Could Provide Income of 109%

CNBC reported, Wayfair (NYSE: W) recently reported a double-digit gain in first-quarter revenue, but losses widened amid high costs.

Wayfair’s revenue rose 39% to $1.94 billion in the first quarter of the year, compared with the $1.92 billion expected by analysts, according to Refinitiv.

Wayfair’s loss widened to $200.4 million, or $2.20 a share, from $107.8 million, or $1.22 a share, during the same period a year earlier. On a pro forma basis, it lost $1.62 a share, but that was steeper than the $1.60 a share loss analysts were expecting.

The company also said it had 16.4 million active customers in the first quarter, 39% greater than the same period last year.

Although its number of repeat customers rose from a year ago and the average order value crept up to $237 in the first quarter, expenses are still weighing on the company’s bottom line. Wayfair said it is investing in its logistics infrastructure and new product offerings.

The company is also spending a lot to acquire new customers, according to Daniel McCarthy, an assistant professor of marketing at Emory University. He has been warning about this trend for some time. In the first quarter, customer acquisition costs were $88 per customer.

The Boston-based company’s stock has become notorious for attracting short sellers within the online retail sector. Skeptics have highlighted that while the company has been able to master the art of selling furniture online, it has yet to do so profitably. And the recent earnings report did little to quell investor concerns.

High short interest does not seem to have hurt the stock which has been consolidating within a relatively narrow trading range for some time.

Wayfair daily

The consolidation is clear on the weekly chart of the stock which shows consolidation after gains is a typical pattern for the company. However, without strong earnings the most recent consolidation could give way to weakness and the price action shows two failed attempts at new highs.

Wayfair weekly

 A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry 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.

A Bear Call Spread in W

For W, we could sell a July 19 $140 call for about $6.32 and buy a July 19 $145 call for about $3.71. This trade generates a credit of $2.61, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $261. The credit received when the trade is opened, $261 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $239. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($261).

This trade offers a potential return of about 109% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if W is below $140 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $239 for this trade in W.