Under Armour has been one of the best growth stocks to own over the last several years. Each quarter, the company was hitting double-digit revenue growth rates. But nothing can last forever.
It seems that UA has finally arrived in the big leagues with Nike and Adidas. It is still growing, just not like it used to. Instead, investors are beginning to see it as just another stable, athletic-wear company.
While that’s not bad, this transition from high growth to flat and boring comes with a changing of the guard. Growth and momentum investors are leaving. Once that blows over, the long-term and steady investors will likely pick up the reins. But that could take a while. And the company doesn’t yet want to head in that direction.
This week, the company announced its five-year growth plan. By 2023, it plans to return to double-digit growth rates. Analysts certainly don’t agree.
Immediately following the announcement, analysts at CFRA downgraded its UA rating to “strong sell.” That doesn’t give you much confident following what was supposed to be a reassuring growth strategy pronouncement.
Those analysts also cut their price target for the company to $15 per share. That’s more than 25% below where the stock was trading before the 5-year plan was released… and 32% below where it was just one week ago.
Now, shares of UA are still up on the year. In fact, even with this recent downturn, it is still one of the best gainers in 2018. The question remains: will it continue to fall.
The jury is still out. In just the last two days, it has given up more than $3 in share price. For a sub-$20 play, that’s substantial. There certainly seems to be more room to fall. After all, the company doesn’t have strong earnings to catch it on the downside.
If the company is just not expected to grow amuch nd doesn’t have a solid bottom line, there’s much to be desired for new investors to make any moves.
The next opportunity for the company to really impress upon investors that it is indeed moving in the right direction toward growth again won’t be until February, when it announces its 2018 full-year numbers.
This points to a short to medium period of weakness. Fortunately, there’s a strategy for that.
An Income Strategy For Short-Term Weakness
When you think a stock is going to remain weak or fall from the price it is currently trading, one way to profit would be to short its shares. But that is a messy process. First, you’d need to borrow the shares from you broker, pay margin fees and hope you aren’t squeezed out of your position.
Another avenue to profit from falling share prices are put options. You can buy a put for much less down than shorting a stock costs. However, if shares move sideways instead of down, you’re out of luck.
But there is another way. By using a bear call spread, bearish traders can collect income at the start of the trade. If shares go down, they keep the whole credit. Here’s how it works.
To initiate a bear call spread, a trader would sell a call option with a strike price at or near the current trading price of the underlying stock. He would then buy a call option with a higher strike price. Since the sold call would have a larger premium, this works out to be a credit spread trade.
You can see how that works here:
Source: The Options Industry Council
The most the trader can make is the amount he received at the start of the trade. But the most he would stand to lose is limited to the difference in strike prices less the credit he received.
So, yes, the profit potential is limited with this kind of trade. But so is the downside risk, a benefit neither shorting stock nor buying a put option gives the trader.
Let’s take a look at a specific trade.
A Specific Trade For UA’s Weakness
A trader looking to enter a bear call spread right now on UA could sell a December 21 $17.50 call for $0.76 per share and buy a December $18.50 call for $0.30 per share. Since each option represents 100 shares, that results in a net credit of $46 to his account ($0.76 – $0.30 = $0.46; $0.46 x 100 shares = $46).
That’s the maximum profit potential on this trade. Of course, the more contracts used, the higher this profit could grow.
The total risk of this specific trade is found by taking the difference in strike prices ($18.50 – $17.50 = $1), subtracting the credit received ($1 – $0.46 = $0.54) and multiplying that by 100 shares ($0.54 x 100 = $54). So, the most a trader could lose on this play is $54 per contract.
That means, the $46 credit represents an 85.2% return on the amount at risk. Shares would have to drop below $17.50 over the next week to deliver this full return. They are trading at $17.75 right now.
A movement of just 1.4% over six trading days is highly likely. After all, over the last six, UA shares have lost more than 30%.
— The Option Specialist