163% Profit Potential With This ‘Great’ Company

What do you get when you have a company reporting a record ninth straight year of growing revenues and earnings, an earnings surprise of 232% and a positive outlook suggesting that its win streak will continue for yet another year?

You probably wouldn’t say a 15% drop in share price. But that’s exactly what Six Flags (SIX) is seeing today. The amusement park company reported an absolutely stellar year and fourth quarter this morning.

Its top line jumped 7.7% to $1.5 billion in 2018. Diluted earnings per share flew to $3.23, a 4.5% annual rise. Yet this is what investors are seeing for SIX’s stock:


There seem to only be two reasons for this fall. Neither of them are very good or should cause such a large tumble. But here they are.

First, Six Flags’ CEO noted that the company lost about $15 million in the quarter due to the “macroeconomic problems” in China. The company has postponed the opening of a theme park in the country due to the slowdown we’ve all seen there.

You might be thinking this sounds bad. But to put that in perspective, $15 million represents just 1% of the company’s top line. In fact, international revenues in total only account for 3% of the company’s sales. This is just a situation where investors are being too tight with their money. It doesn’t matter if China cuts off trade overnight and kicks out all U.S. companies. Six Flag’s business won’t really be affected.

The second reason investors seem to be panicking has at least some small amount of merit. The company had previous had a target of $750 million in modified EBITDA by 2020. Basically, it set a target to make a specific amount of money by a specific date. It now says that that target will be harder to hit, and it might need until 2021 to do it.

That’s a reasonable reason for some small selloff. Investors hate when companies miss targets. But this is such a specific and small transgression when you consider it has been blowing past all of its other targets.

Six Flags’ income has more than quadrupled in the last five years. That is not even slowing down. The company has projected 2019 will be its 10th consecutive year with both top and bottom-line growth.

This is a clear growth company. And for some investors seeing through the bad headlines today, they can see another rare find in SIX’s stock. It pays a 6% dividend now that shares have fallen so far. That’s unheard of. Companies growing at this kind of rate don’t ordinarily pay such a large dividend.

So, right now, with shares depressed they offer both large growth and seemingly great value. However, that doesn’t mean you should absolutely go out and buy as many shares as you can.

You see, no matter what the current picture is, there’s always a chance of a big problem. The company’s business is amusement parks. You’ve likely already saw headlines about how tax refunds are down this year and the Fed is starting to rethinking rising interest rates. Investors and consumers alike are starting to fear an economic slowdown. That’s bad for all companies… but especially terrible for a company like SIX.

So, with a clear market overreaction, yet valid long-term worries about an overall economic impact on the company, simply buying its stock might not be a good enough trade.

Fortunately, there is one type of trade that benefits from short-term overreactions without putting much capital at risk at all.

A Strategy For a Short-Term Overreaction

A bull call spread is a type of trade that lets you invest in a share price’s rise without risking a lot of money. The way it works is by using two call options strategically.

First, you’d buy a call option on a stock you believe is going to rise in value over a certain amount of time. Then, you’d sell a second call option on that same stock with the same expiration date but a higher strike price. The premium from this second option offsets part of the cost to buy the first.

This creates a net debit trade, meaning there is some initial outlay to open the trade. But that small entry cost is the only money you could lose on the whole trade.

You’d make money on the trade if shares rose higher than the second strike price (the one on the call you sold). The total profit is found by taking the difference in strike prices and subtracting the entry cost of the trade.

Here’s how this hypothetical trade would look:


Source: The Options Industry Council

Let’s look at a specific example using SIX’s unique opportunity.

A Specific Trade For SIX

If a trader believed Six Flags’ stock is likely to rise between now and March 15, he could open a bull call spread trade on SIX with that expiration date. A sensible option for him would be to buy a March 15 $55 call for $1.80 per share and sell a March 15 $57.50 call for $0.85 per share for a net debit of $0.95 per share. Since each option represents 100 shares of SIX, that’s a total entry cost of $95.

That $95 is the total amount the trader would have to lose if this trade goes south. If shares continue to fall after today’s incredible decline, he would indeed lose that money. But if they don’t… and they in fact rise back to where they were just a few hours ago or higher… he’d do much better.

To find his maximum potential return, find the difference in strike prices ($57.50 – $55 = $2.50) and subtract the cost of the trade ($2.50 – $0.95 = $1.55). On 100 shares, that’s a potential return of $155. In other words, this trade offers a potential 163% return on the amount of money at risk. That’s a pretty good trade off.

For this play to hit that top return, shares of SIX would have to reach $57.50 by the middle of next month. To put that in perspective, they were trading yesterday above $63. They’d only need to recover less than one-third of today’s decline to make the trader his full return.

— The Option Specialist

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About the Author: The Option Specialist