It almost causes a double take whenever you hear about a new gadget or tech device that has instant popularity, yet it isn’t from Apple… or even Samsung. But that’s exactly the case with Fitbit.
Even with its hit popularity, however, Fitbit has been struggling to reach true profitability for a while. The company, by complete surprise to its analysts, just did that this week.
Analysts expected a loss of one cent per share for the quarter. Fitbit’s earnings came in at four cents per share. Revenues jumped to $393.6 million during the quarter as well, $12.4 million higher than expectations.
Part of this success stems from getting a waver from the trade wars consuming Washington. The latest round of Chinese tariffs excludes certain electronic products. Fitbit devices made the list of exclusions.
The second boom could be an even longer-lasting one for the company, when it announced a new Fitbit Care platform in September. This opens the company up to a wide range of potential new customers in the healthcare field. With less than a month of incomes from this market, it might have an even larger impact going forward.
These surprise results sent investors flocking to the company’s shares late Wednesday and all-day Thursday. In just the Thursday session, FIT scorched 28.4% higher.
Now, it will be impossible to say just how long this success will last. The company’s fourth quarter is always the big one for it, considering the holiday shopping season for its products. Each Q4 amounts to about twice the revenues and earnings of any other quarter during the year.
It is also unclear how long the Trump Administration will protect Fitbit’s products from the swirling devastation of the tariff wars with China.
This excitement and uncertainty can make for a nervous stock investor. Shares could continue their recent climb if Fitbit has another quarter or two of this kind of performance. Alternatively, shares could easily resume their slide prior to this announcement:
Option investors, however, don’t have such a dilemma.
Growing Uncertainty of FIT’s Future Brings Opportunities
As we’ve discussed plenty of times in these pages, options are a play more on a company’s stock price volatility than its actual financial performance. So, when we find a situation like this one, it sets options up as the preferred way to play it.
A simple call option prior to this announcement could have brought the buyer enormous returns overnight. I’m talking 459% for FIT November 16 $5 calls from Wednesday’s close until late afternoon on Thursday.
But, making that move then would have been a gamble. One-day, 28% stock movements aren’t common, after all.
So, instead of taking such a long-shot chance at large short-term gains in the option market, we prefer to simply trade the volatility… not direction.
There’s a strategy we like to use in situations like this. We can’t tell if a stock is going to continue to rapidly increase… or revert to a freefall. Instead, we trade both directions.
How to Play a Volatile Stock With a Straddle
A long straddle is a options strategy that takes advantage of large movements in the underlying stock’s price during the duration of the trade. But the best part of using this strategy is that it doesn’t matter which direction those movements will go in.
The way a long straddle works is to buy both a call option and a put option with the same strike price and expiration date. That lets you take advantage of any movement away from that price.
It works best in an environment like FIT finds itself in. We know that the company will continue to experience volatility, especially as the recent earnings announcement news cools down and we enter holiday shopping season. But as we noted, that could come in the form of rapid increases on news of continued success… or large losses on weaker results, negative impacts from tariffs or continued competition from the likes of the Apple Watch.
The upside profit potential is virtually unlimited. Meaning you get to continue profiting the further away from this trade’s strike price FIT’s stock goes.
The maximum risk of this trade is simply the cost to open it. Since it requires you buy both a call option and a put option, you have to pay out to get into this trade. But that’s the only risk you face, losing your initial outlay. This is represented in this diagram of a long straddle:
Source: The Options Industry Council
A Specific Long Straddle Trade in FIT
To enter into a straddle in Fitbit right now, you could buy November 16 $6 calls for $0.41 per share (or $41 per contract, each worth 100 shares) and buy the November 16 $6 puts for $0.33 per share (or $33 per contract). Therefore, the cost to enter this trade is $0.74 per share or $74 per contract. That’s the maximum you would have at risk for the whole duration of this trade.
As we noted, the maximum profit potential is limitless. If shares of FIT continue to rally, your put contracts would become worthless. But your call would go deep in-the-money, representing large returns, far surpassing your $74 entry price.
Likewise, if shares collapse, your call won’t be worth anything. But your put contracts would bring you large returns.
That $0.74 per share is just 12.3% of Fitbit’s $6.02 trading price. That means it won’t take much of a movement from here to put you in profit territory on this trade.
As we said, that’s less than half of what FIT moved in just one day this week. And it takes just a glance at the company’s 2018 stock chart to see that a 12.3% movement is tiny compared to how FIT often moves.
— The Option Specialist