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VC Provides a Stock Tip

VC Provides a Stock Tip

Source: Docusign.com

Venture capital, or VC, is usually provided to companies that are in the startup phase. These are companies that could deliver fast growth. It’s a type of financing provided to startups that are believed to have long-term growth potential.

Venture capital generally comes from well-off investors, investment banks and any other financial institutions. However, it does not always take just a monetary form; it can be provided in the form of technical or managerial expertise.

Though it can be risky for the investors who put up the funds, the potential for above average returns is an attractive payoff. For new companies or ventures that have a limited operating history (under two years), venture capital funding is increasingly becoming a popular source for raising capital.

This can be especially true if the company lacks access to capital markets, bank loans or other debt instruments. The main downside from a company’s perspective may be that the investors usually get equity in the company, and thus a say in company future decisions.

VC Flows Can Help Spot Growth Companies

VC investing is often limited to institutional investors and high net worth individuals. While many individuals are unable to access the market, they can find ways to benefit from the sector.

Recently, it was announced that software company Conga has raised $47 million in backing from Insight Venture Partners and Salesforce Ventures that will help it keep up steady growth after a string of acquisitions.

The company, which makes tools to help companies compose and edit documents and check contracts from within Salesforce.com (NYSE: CRM), now has raised $117 million total from its VC backers in recent years.

Conga attracted the most recent investment from its existing investors because of the opportunities the company has to expand, said CEO Matt Schiltz.

According to BizJournals.com, “The company is building a team to make Conga a bigger and more profitable company. Its evolution reminds [CEO] Schiltz of the growth of DocuSign, where he was CEO for four years ending in 2011.

San Francisco-based DocuSign went public in late April in an IPO that valued the company at more than $4 billion.

“Conga has the potential to do very similar things, and we need to invest in the team to make that happen,” Schiltz said.”

DOCU has delivered significant gains since its initial public offering.

DOCU daily chart

Now that the stock has delivered a large gain, traders might be wary of jumping in, worried that the stock could pull back after the sharp rally on the news.

A Trade for Short Term Bulls

As with the ownership of any stock, buying DOCU 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.

bull call spread

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 prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for DOCU

For DOCU, the June 15 options allow a trader to gain exposure to the stock.

A June 15 $55 call option can be bought for about $2.15 and the June 15 $60 call could be sold for about $0.85. This trade would cost $1.30 to open, or $130 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 $130.

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 DOCU the maximum gain is $3.70 ($60 – $55 = $5.00; $5.00 – $1.30 = $3.70). This represents $370 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $130 to open this trade.

That is a potential gain of about 180% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.