WD-40 Could Deliver Possible Income of 75%
Trade summary: A bear call spread in WD-40 Company (Nasdaq: WDFC), using April 17 $150 call options for about $7.40 and buy an April 17 $160 call for about $3.10. This trade generates a credit of $4.30, which is the difference in the amount of premium for the call that is sold and the call.
In this trade, the maximum risk is about $570. The risk can be found by subtracting the difference in the strike prices ($1,000 or $10.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($430). This trade offers a potential return of about 75% of the amount risked.
Now, let’s look at the details.
The company recently reported earnings according to PR Newswire,
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“WD-40 Company, a global marketing organization dedicated to creating positive lasting memories by developing and selling products that solve problems in workshops, factories and homes around the world, today reported financial results for its second fiscal quarter ended February 29, 2020.
Total net sales for the second quarter were $100.0 million, a decrease of 1 percent compared to the prior year fiscal quarter. Year-to-date total net sales were $198.6 million, a decrease of 2 percent compared to the prior year fiscal period.
Net income for the second quarter was $14.3 million, a decrease of 10 percent compared to the prior year fiscal quarter. Year-to-date net income was $26.5 million, a decrease of 9 percent from the prior year fiscal period.
Diluted earnings per share were $1.04 in the second quarter, compared to $1.14 per share for the prior year fiscal quarter. Year-to-date diluted earnings per share were $1.92 compared to $2.09 in the prior year fiscal period.
“Our total sales declined in the second quarter primarily due to a 31 percent decline in sales within the Asia-Pacific segment,” said Garry Ridge, WD-40 Company’s chairman and chief executive officer.
“This decline was mainly driven by a significant decrease in maintenance product sales in China due to disruptions related to the COVID-19 outbreak and resulting health crisis. Though the impact in the second quarter was significant, we are pleased that things appear to be slowly returning to normal for our tribe members in China.”
“However, we currently find ourselves at the peak of uncertainty as it relates to this global health crisis and its effects on both our company and the global economy. To navigate these unprecedented times, we have three primary areas of focus for the company.
First, the safety and wellbeing of our tribe members and their families is our top priority. Second, we need to stay connected with our customers and vendor partners to ensure we continue to meet market needs. Third, we need to maintain the infrastructure of our business operations. In support of this third area of focus, we have recently taken steps to strengthen our balance sheet.”
“We know we will probably face some challenges in the coming weeks and months as we continue to operate a global business through these volatile and uncertain times. But we are a strong tribe and an enduring company.
We are confident that we are well positioned to navigate this storm as it unfolds from both a financial and operational perspective and emerge on the other side a stronger company,” concluded Ridge.
Overall, the comments present concerns that the company might face challenges on the current quarter. That could at least partly explain the stock’s recent weakness.
The longer-term chart shows that WDFC is near support. A break could lead to a significant decline in the stock.
Greater than average volatility makes the options attractive for an income strategy.
Buying shares of the stock exposes traders to significant risks in dollar terms. A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.
A Specific Trade for WDFC
For WDFC, we could sell an April 17 $150 call for about $7.40 and buy an April 17 $160 call for about $3.10. This trade generates a credit of $4.30, 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 $430 The credit received when the trade is opened, $430 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $570. The risk can be found by subtracting the difference in the strike prices ($1,000 or $10.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($430).
This trade offers a potential return of about 75% 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 WDFC is below $150 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 $570 for this trade in WDFC.
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.
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.