Whirlpool Delivers a Surprise
Tariffs are a big story. In the news, they are supposed to help companies by making imports more expensive compared to goods made in the U. S. But, it might not be working that way.
In January, the Trump administration announced that it will impose a 20 percent tariff on the first 1.2 million imported large residential washing machines in the first year and a 50 percent tariff on machines above that number.
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But, the tariff doesn’t seem to be working as intended for at least one washing machine maker. Whirlpool Corporation (NYSE: WHR) announced earnings that failed to meet expectations. Management blamed a variety of factors.
One reason for the shortfall according to the company’s CEO Marc Bitzer was the fact that the cost of steel and resin that go into making the large metal boxes that become washing machines, dryers, stoves and refrigerators that the company manufactures.
He also cited the cost of freight shipping which are affected by the cost of fuel and a shortage of drivers in the trucking industry.
Related to the price of steel, Bitzer said the company had some cushion, as it negotiates annual contracts and they haven’t been strongly affected this quarter, but resins, used to make the insides of some appliances, have no annual contracts, making it harder to contain costs.
In the earnings announcement, Whirlpool said it expects to pay about $350 million more this year for raw materials, up from an earlier estimate for added costs as high as $175 million.
This all led the company to a second-quarter loss after booking $747 million in charges on its European business and paying $114 million for an antitrust settlement in France.
Management also trimmed its full-year profit outlook, cutting the midpoint of its 2018 guidance by 3%. It now expects adjusted profit per share of $14.20 to $14.80.
Results Prompt a Reevaluation of Tariffs
This is all in sharp contrast to Bitzer’s thoughts in January. Then, according to The Wall Street Journal, “[Bitzer] celebrated his win over South Korean competitors LG Electronics Inc. and Samsung Electronics Co.
“This is, without any doubt, a positive catalyst for Whirlpool,” he said on an investor conference call.
In his next call with investors, in April, Mr. Bitzer struck a cautious tone. “There continues to be uncertainty regarding potential future tariffs and trade actions,” he said. “We’ll continue to monitor, evaluate and take the right action for our business.”
Now, there is less uncertainty as tariffs weigh on the company and the stock price.
The longer-term chart using weekly data confirms the bearish tone of the daily chart shown above.
A Trading Strategy To Benefit From Weakness
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook for the short term, a call option should be sold.
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 is important to consider is the bear call spread. This trade 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, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy 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.
A Bear Call Spread in WHR
For WHR, we have a number of options available. Short term options allow us to trade frequently and potentially expand our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell an August 17 $130 call for about $3.00 and buy an August 17 $135 call for about $1.25. This trade generates a credit of $1.75, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $175. The credit received when the trade is opened, $175 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $325. The risk is 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 ($175).
This trade offers a potential return of about 53% of the amount risked for a holding period that is about three weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if WHR is below $130 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 $325 for this trade in WHR.
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