Ford in the Hot Seat

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For value investors, there’s been no more confusing a stock than Ford over the last several years. The company has seen a clear decline in volumes, revenues and earnings. But its shares have fallen even further than those.

As you can see, 2018 was a terrible year for the second-largest US automaker:

Screen Shot 2019-07-22 at 12.05.37 PM.png

This year, however, it pulled a 180°. This wishy-washy performance is only going to heighten as the company enters a period of intense pressure.

First of all, the company is going back to the negotiation table with the United Automobile Workers union, or UAW. This is the first renegotiation over terms between the automaker and the chief worker union in the industry since 2015, when sales were heading in a much more positive direction.

Since then, auto sales in the U.S., where the vast majority of Ford’s business comes from, have started to fall off a cliff. In the first half of 2019, just as F’s share price was shooting up 27%, new vehicle sales in the U.S. dropped 2.2%. Ford’s competitors have felt the blow just as much, with General Motors closing five plants, much to the UAW’s chagrin.

Ford has this upcoming negotiation on the heels of some other major industry shifts. The company had been falling well behind its peers on the self-driving and electric car fronts. Anyone interested in the industry points to these two fast-growing segments as the future drivers of the auto industry.

That could be changing, although it is likely too early to tell. Ford recently signed a deal with Volkswagen to share the development of these two areas. Under the agreement, Volkswagen will lay out $2.6 billion in cash to plow into Ford’s Argo AI subsidiary. Argo is developing its own autonomous vehicle technologies.

In exchange, the German company will be able to take any ideas developed to run with, and Ford gets access to Volkswagen’s battery technology for its electric cars.

While this deal could have wide-ranging effects – presumably positive ones – for each automaker, the ink is still wet. So, investors wait to see.

If that was all that was going on at Ford, it would be enough to take interest in the company’s shares. But there’s more.

Ford’s last week also came with a new recall on 60,000 of its Focus model vehicles due to deformed fuel tanks. Any recall news is painful for auto investors. We won’t really know how bad this one is for a few more weeks.

Finally, earnings season. It is falling on Ford right as all of this is stirring up investors. The company reports next Wednesday. If the last few are anything to go by, shareholders should hold onto their seats. The company has missed two of the last four quarterly estimates. However, its most recent quarterly EPS came in significantly higher than expectations.

So, trying to predict what will happen next week is nearly impossible. Fortunately, options traders don’t have to. There’s a way to play all of this turmoil in the auto giant, ahead of earnings, negotiations and all the rest without gambling on which direction any of it will send Ford’s shares.

Let’s get right into it…

A Strategy For Short Term Volatility

It’s clear that for Ford, we’re going to be looking at a volatile second half of 2019. The next month alone will come with plenty of questions and tough answers, likely to send shares gyrating wildly.

One way to play this expected volatility is by using a strategy called a long straddle. A long straddle is a type of trade that involves buying both a call and a put with the same strike price and expiration date.

Since Ford is sitting just above $10 per share, that’s the ideal place to start. The idea being that the further prices move away from that strike price, one of the two legs will go up in value. If shares continue to rally like we’ve seen, the call would take off. If the company disappoints next week or faces any more negative news, the puts could pay off.

In either case, what we’re looking for is amount of movement… not direction. You can see how this type of trade plays out:


Source: The Options Industry Council

Clearly, the greater the movement, the greater the profits. But notice too that no matter what happens, the amount at risk is capped… right at the amount it costs to enter the trade. For a multileg options strategy, this is an ideal situation. Risk is capped and profit potential is limitless.

Let’s look at a specific trade to see what traders could expect.

A Specific Trade on Ford

Right now a trader could buy an August 16 $10 call for $0.37 per share and an August 16 $10 put for $0.24 per share for a net debit of $0.61 per share. Since each contract is worth 100 shares of F, that’s a total entry cost of $61.

That $61 is the most at risk during this month-long trade. And as noted, that’s capped at that amount. The only way for the trader to realize that loss would be if Ford’s stock doesn’t move over the next month. Considering all that’s going on, especially that much-anticipated earnings next week, that’s quite unlikely.

The profit potential is nearly unlimited. The further Ford either rallies or drops from this $10 price point, the greater one of the two legs will profit.

To find the exact point at which this trade enters profit territory, compare the cost to the strike price. For instance, if shares decline, they’d have to fall below $9.39 ($10 – $0.61 = $9.39) for the put to profit enough to cover the cost. Likewise, they’d have to rise past $10.61 ($10 + $0.61 = $10.61) for the call to.

In either case, that represents about a 6.1% move from the strike price. That’s definitely on the table with all the next month will entail for Ford.

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