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Traders Sell an Earnings Beat

Traders Sell an Earnings Beat

For this stock, it’s possible to summarize the story in a few words, “earnings beat, stock falls $5.”

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  • GlobeNewswire reported, “Exponent, Inc. (Nasdaq: EXPO) reported financial results for the third quarter of fiscal year 2019 ended September 27, 2019.

    “Exponent reported high-single digit net revenue growth during the third quarter, representing continued execution on positive market trends, while lapping the large human factors study that concluded during the third quarter of 2018” commented Dr. Catherine Corrigan, President and Chief Executive Officer.

    “We continue to leverage our reputation for reactive services in the United States to build our brand internationally and in proactive services.

    We experienced demand from a broader set of industries involving energy storage and battery technologies, continued our integrity management assessments related to the utilities industry, and saw our international arbitration work expand geographically.

    Our human factors and product studies continue to provide unique insights into the operability, usability and safety of human-machine systems across a diverse set of focus areas.”

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  • Total revenues in the third quarter of 2019 grew 7% to $101.5 million, as compared to $95.3 million in the same quarter of 2018. Revenues before reimbursements increased 8% to $95.5 million as compared to $88.7 million in the same period one year ago.

    Net income increased to $19.6 million, or $0.36 per diluted share, in the third quarter of 2019, as compared to $17.5 million, or $0.32 per diluted share, in the same period of 2018. The tax benefit for the classification of tax adjustments associated with share-based awards realized in the third quarter of 2019 was $1.7 million as compared to $0.1 million in the same period last year.

    EBITDA1 increased to $26.0 million, as compared to $24.8 million in the third quarter of 2018.

    For the first nine months of 2019, total revenues increased 7% to $307.1 million, as compared to $287.4 million in the same period of 2018. Revenues before reimbursements increased 7% to $289.2 million, as compared to $269.4 million in the same period one year ago.

    Net income was $63.3 million, or $1.17 per diluted share, in the first nine months of 2019, as compared to $56.2 million, or $1.04 per diluted share, in the same period of 2018. The tax benefit for the classification of tax adjustments associated with share-based awards realized in the first nine months of 2019 was $7.4 million as compared to $4.2 million in the same period last year.”

    But the stock fell on the news.

    EXPO daily chart

    The longer-term chart shows the decline could mark an important top.

    EXPO weekly chart

    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 EXPO

    For EXPO, we could sell a December 20 $65 call for about $2.60 and buy a December 20 $70 call for about $1.10. This trade generates a credit of $1.50, 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 $150. The credit received when the trade is opened, $150 in this case, is also the maximum potential profit on the trade.

    The maximum risk on the trade in EXPO is about $350. 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 ($150).

    This trade offers a potential return of about 42% 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 EXPO is below $65 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 $350 for this trade in EXPO.

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