We all love a good comeback story… even in investing. You know: a company falls out of favor with investors, does something tough like a reorganization or a changing leadership and then beats all expectations quarter after quarter.
Car rental giant Avis Budget Group (CAR) seems to be fitting that mold right now. It’s not necessarily that the company was in trouble. It just fell out of favor with the market.
From its high last April to its low in December, shares absolutely crashed. They fell 57.5% from peak to trough. But as you can see, that downward trend seems to be over:
Yesterday, after the bell, Avis announced a stellar fourth quarter of earnings. It smashed expectations for both the quarter and the year. It brought in an adjusted EPS of $0.53 in the quarter vs. an estimated $0.37. Revenue came in just at estimates, but that still marks the ninth consecutive year of top-line growth.
That’s quite an impressive feat for a company many have been bearish on. You see, that downward trend it just broke through wasn’t new. Since a wild run up in share price from 2012 to 2014, investors have been slowly selling off the car rental giant.
That’s why this latest uptick is so interesting. Yet, it’s what makes it scary for those just getting in now.
You see, it has been here before. During its slow decline from its absolute peak in 2014, it has had no less than seven separate instances where it recovered by more than 20% only to fall sharply afterwards.
This latest one is starting to look a lot like those previous fake outs.
None of this is to say that the company isn’t worth owning in the long run. In fact, these results coupled with the company’s projections for 2019 and market trends all point to Avis regaining sustainability over the long term. While it’s unlikely to hit $70 again for quite some time, it could have a decent year or two ahead of it.
No, what we’re saying is that this two-month rally its been on is just too much too fast. Investors have clearly shown their inclination to quickly take profits out of CAR stock whenever it rallies this fast.
That leaves us with a unique contrarian opportunity to play this expected profit taking. There’s one strategy we love to use in cases like this. And because of today’s post-earnings super rally, we can do it for cheap…
A Strategy For Short Term Share Declines
A bear put spread is a type of trade that profits when a stock declines. It is different from a straight up long put option position. It is similar, but more tempered.
The way it works is to buy a put option on the underlying stock you think will fall in price just like a regular put position. But to get into a bear put spread, you then sell a second put option with a lower strike price.
What this does is reduce the amount of money you have invested in the trade. And that lowers your total risk. In a moment, we’ll show you a specific trade in CAR where the second put lowers the risk by just over 50%.
This trade does have a drawback, however. Nothing is free. So, to pay for the reduced risk, the maximum potential profit is also reduced.
Source: The Options Industry Council
You profit with this trade the whole time the underlying stock falls… until it drops below that second put option’s strike price. So, that’s the tradeoff. Limiting risk… but also potential profits. For CAR, this is the perfect type of tradeoff.
Let’s look at a specific example…
A Specific Play For CAR
A trader looking to use a bear put spread on Avis could buy an April 18 $34 put for $1.98 per share and sell an April 18 $31 put for $1 per share for a entry cost of $0.98 per share. Since each contract represents 100 shares of CAR, that’s a net debit of $98 to the trader’s account.
That’s the total amount this trade would have at risk for the full two months it is open. Less than $100 down could turn into much more with just a small correction after the earnings buzz dies down in Avis.
To find just how much this trade could return, take the difference in strike prices ($34 – $31 = $3) and subtract the entry cost ($3 – $0.98 = $2.02). On 100 shares, that’s a total potential return of $202 on the $98 it took to enter this trade. In other words, this hypothetical trader could make a 206% return on the amount he had at risk.
For the trader to hit that max return, shares of CAR would have to drop below $31 by April 18. To put that in perspective, they were trading at $29 just yesterday.
We noted above that this bear call spread strategy was perfect for Avis. Sure, you could buy a put and leave it at that… spend nearly $200 and hope CAR shares fall. Or, you can take a 50% discount and walk away with a potential 206% return in less than two months.
— The Option Specialist