Walgreens Could Be a Triple Digit Gain
Trade summary: A bull call spread in Walgreens Boots Alliance, Inc. (Nasdaq: WBA) using the November $37.50 call option which can be bought for about $1.55 and the November $40 call could be sold for about $0.65. This trade would cost $0.90 to open, or $90 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 $90. The maximum gain is $160 per contract. That is a potential gain of about 177% based on the amount risked in the trade.
Now, let’s look at the details.
WBA recently reported earnings as noted at The Street, “Walgreens Boots said its business will “continue to be negatively impacted when compared with the pre-COVID-19” in the first half of the year, but still forecasts low-single digit profit growth for 2021.
WBA posted stronger-than-expected fourth quarter earnings [recently] and said profits in the coming year should continue to grow despite the impact of the coronavirus pandemic.
Walgreens Boots said adjusted profits for the three months ending in September, the group’s fiscal fourth quarter, were pegged at $1.02 per share, down 28.7% from the same period last year but six cents ahead of the Street consensus forecast.
Group revenues, Walgreens said, rose 2.3% to $34.7 billion, just ahead of analysts’ estimates of a $34.37 billion tally.
Comparable U.S. store sales for the group’s retail pharmacy business rose 3.6%, Walgreen said, with total revenues also up 3.6% to $27 billion.
Walgreens Boots said adjusted profits for the coming 2021 year should grow in the “low single-digit’ percentage range, although the first half of the year will be negatively impacted by the ongoing coronavirus pandemic.
“I am pleased to report results that came in at the high end of our expectations as we continue to adapt and transform our business model to changing customer needs,” said CEO Stefano Pessina.
“Despite uncertainty amid the global COVID-19 pandemic, we are seeing gradual improvement in key U.S. and UK markets and continued strong performance in our wholesale business. I’m also encouraged by the accelerating growth in our e-commerce platforms.”
“Now, more than ever, our pharmacy-centered business is at the heart of community healthcare and we are expanding on that role for the future,” he added.
“I continue to be inspired by the tireless efforts of our teams as they support and care for our customers, patients and communities, while accelerating progress on our clear set of strategic priorities. Looking ahead, we are projecting adjusted EPS growth in fiscal 2021, as reflected in our new guidance.”
The stock moved higher on the news.
The monthly chart shows the long-term bear market in WBA. The stock peaked in 2014.
The stock is now trading with a price to earnings (P/E) ratio of 12.7 based on earnings over the past 12 months. The P/E ratio is 7.8 based on expected earnings. Both levels are multiyear lows and could be attractive to value investors.
Source: Standard & Poor’s
A Specific Trade for WBA
For WBA, the November 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.
A November $37.50 call option can be bought for about $1.55 and the November $40 call could be sold for about $0.65. This trade would cost $0.90 to open, or $90 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 $90.
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 WBA, the maximum gain is $160 ($40- $37.50= $2.50; 2.50- $0.90 = $1.60). This represents $160 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $90 to open this trade.
That is a potential gain of about 177% 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 WBA 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.