Zillow Offers New Potential for a 122% Gain For Investors
Trade summary: A bull call spread in Zillow Group, Inc. (Nasdaq: ZG) using the March 20 $65 call option which can be bought for about $2.57 and the March 20 $70 call could be sold for about $1.02. This trade would cost $1.55 to open, or $155 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 $155. The maximum gain is $345 per contract. That is a potential gain of about 122% based on the amount risked in the trade.
Now, let’s look at the details.
Zillow (Nasdaq: Z) shares touched record levels after the real estate information company beat earnings estimates and was the subject of numerous analyst notes.
Wedbush analyst Ygal Arounian raised his price target to $65 a share from $39.
The Street reported,
“The opportunity is large, but Zillow is going through a gigantic pivot that we don’t want to underestimate the challenges of, particularly as the race to dominate the end-to-end residential real estate technology stack picks up,” Arounian said.
Benchmark Capital also raised its price target from $75 from $59.
“Zillow appears to have already baked in some 2020 cushion via Flex testing,” Benchmark analyst Daniel Kurnos wrote. “It always seems to be a bumpy ride but we expect Zillow will be able to continue its momentum over the course of the next 12 months.”
Goldman Sachs analyst Heath Terry raised his price target to $57 from $39, though the firm maintained its neutral rating. “We continue to believe in the long-term opportunity for Zillow to leverage its brand, traffic, data, and resources to create efficiencies in the real estate market,” Terry wrote.
Guggenheim affirmed its buy rating and $54 price target as the firm sees Zillow continuing to receive a pass on its “negative unit economics,” and the loss from the fast-growing home-flipping unit.
Zillow reported a net loss of 49 cents a share compared with 48 cents in the year-earlier quarter. Revenue reached $943.9 million from $365.3 million.
A survey of analysts by FactSet was estimating the company would post a GAAP net loss of 57 cents a share, or an adjusted 35 cents, on revenue of $814.6 million.
The longer term chart below shows AG is below its 2018 highs. This reflects the company’s fundamentals with earnings expected to be several years away. Analysts expect a loss of about $1,05 per share this year narrowing to less than $0.70 per share next year.
Despite the fact that fundamentals don’t support the price, new products could. The company now flips homes using its information advantage and scale to buy homes and resell them, potentially at a significant profit.
ZG can offer sellers a quick close because they have capital and systems in place to prepare the documents. They can then resell at lower costs to buyers who can get a below market price because commissions can be lower since ZG has volume.
Overall, the advantage could be short lived since prices will reset to the lower level. But the short term is bullish.
A Specific Trade for ZG
For ZG, the March 20 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 March 20 $65 call option can be bought for about $2.57 and the March 20 $70 call could be sold for about $1.02. This trade would cost $1.55 to open, or $155 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 $155.
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 ZG the maximum gain is $3.45 ($70- $65= $5; $5 – $1.55 = $3.45). This represents $345 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $155 to open this trade.
That is a potential gain of about 122% in ZG, 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 ZG 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.
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.