Yo Yo Dieting Could Explain This Company’s Results
Yo-yo dieting is a term coined by Kelly D. Brownell at Yale University, in reference to the cyclical loss and gain of weight, resembling the up-down motion of a yo-yo.
In this process, the dieter is initially successful in the pursuit of weight loss but is unsuccessful in maintaining the loss long-term and begins to gain the weight back. The dieter then seeks to lose the regained weight, and the cycle begins again.
It’s not healthy and individuals caught in this cycle have every right to be unhappy about the situation. That’s one reason some companies have developed strategies and products to help dieters avoid this problem. Among this companies is Weight Watchers International, Inc. (Nasdaq: WTW).
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WTW is a provider of weight management services. The company operates globally through a network of company-owned and franchise operations.
The company’s branded products and services include meetings conducted by its franchisees, digital weight management products provided through its websites, mobile sites and applications, products sold at meetings, licensed products sold in retail channels and magazine subscriptions and other publications.
It operates around the world and sells a range of products, including bars, snacks, cookbooks, food and restaurant guides with SmartPoints values, Weight Watchers magazines, SmartPoints calculators and fitness kits, and certain third-party products, such as activity-tracking monitors.
It sells its products through its meetings business, online and to its franchisees. It includes a range of nutritional, activity, behavioral and lifestyle tools.
Results Have Investors Feeling Like Yo Yo Dieters
According to TheStreet, the stock fell sharply, down as much as 30%, after the weight management company saw its subscribers continuing to decline and the company missed third-quarter sales expectations.
The company, which recently changed its name to WW, posted third-quarter net income of $70.1 million, or $1 per share, up from $44.7 million, or 65 cents, a year ago.
Revenue totaled $366 million, up 14% from a year ago, but missed analysts’ expectations of $379 million.
The company said it ended the third quarter with 4.2 million subscribers, up 25% year over year, but that number fell from 4.6 million subscribers in the first quarter of the year and 4.5 million in the second quarter.
“Historically, approximately 40% of our annual member recruitments have occurred during the first quarter,” Chief Financial Officer Nicholas Hotchkin said during a conference call with analysts.
“Therefore, each year first quarter is our peak for end of period subscribers and each year end is our low point.”
Hotchkin added that “subscribers that come in at year end show up in our End of Period Subscriber metric but the real impact in terms of their financial contribution isn’t realized until the next fiscal year.”
The down move after the report continues the roller coaster pattern in the stock price investors have experienced for some time.
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.
A Bear Call Spread in WTW
For WTW, we could sell a December 21 $50 call for about $4.85 and buy a December 21 $55 call for about $2.60. This trade generates a credit of $2.25, 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 $225. The credit received when the trade is opened, $225 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $275. The risk can be 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 ($225).
This trade offers a potential return of about 81% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if WTW is below $50 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 $275 for this trade in WTW.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.