Upbeat Guidance Could Drive a 75% Gain for Investors
Trade summary: A bull call spread in The Cooper Companies, Inc. (NYSE: COO) using the October $320 call option which can be bought for about $16.95 and the October $330 call could be sold for about $11.25. This trade would cost $5.70 to open, or $570 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 $570. The maximum gain is $430 per contract. That is a potential gain of about 75% based on the amount risked in the trade.
Now, let’s look at the details.
GlobeNewswire reported that COO announced financial results for its fiscal third quarter ended July 31, 2020.
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“Commenting on the results, Albert White, Cooper’s president and chief executive officer said, “While our third quarter results were negatively impacted by COVID-19, we solidly exceeded expectations as we experienced a faster than expected recovery. Both of our businesses improved as we progressed through the quarter and this momentum continued in August.”
Revenue $578.2 million, down 15% from last year’s third quarter, down 14% in constant currency.
Gross margin 62% compared with 66% in last year’s third quarter. On a non-GAAP basis, gross margin was 66%, down from 67% last year on higher expenses associated with COVID-19, partially offset by product mix at CooperVision.
Operating margin 12% compared with 21% in last year’s third quarter. On a non-GAAP basis, operating margin was 23%, down from 28% last year driven by the decline in gross margins combined with heightened operating expenses as a percent of sales due to COVID-19 related costs.
Interest expense $5.7 million compared with $16.7 million in last year’s third quarter driven by lower interest rates.
Total debt outstanding at the end of the quarter was $1,880.4 million with quarter-end cash and cash equivalents of $127.4 million. Adjusted leverage ratio (net debt over adjusted EBITDA) of 2.23x.
Cash provided by operations $112.8 million offset by capital expenditures $45.1 million resulted in free cash flow of $67.7 million.
The Company provided its fiscal fourth quarter 2020 guidance. Details are summarized as follows:
Fiscal fourth quarter 2020 total revenue $665 – $693 million
– CVI revenue $500 – $520 million
– CSI revenue $165 – $173 million
Fiscal fourth quarter 2020 non-GAAP diluted earnings per share $3.00 – $3.20.”
COO is now breaking out of consolidation.
The weekly chart shows that there is potential resistance near $350. This could limit upside potential for traders who buy the stock.
For high priced shares with limited potential based on the chart, a spread trade could be a lower risk, more potentially profitable trade.
A Specific Trade for COO
For COO, the October options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
An October $320 call option can be bought for about $16.95 and the October $330 call could be sold for about $11.25. This trade would cost $5.70 to open, or $570 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 $570.
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 COO, the maximum gain is $430 ($330- $320= $10; 10- $5.70 = $4.30). This represents $430 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $570 to open this trade.
That is a potential gain of about 75% 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 COO 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.