In the shoe business, no name is bigger than Nike. And no company has been so controversial for so many different things. But none of that matters when it comes to investors.
Despite failed sponsorship deals and shocking headlines that have caused political feathers to ruffle, investors have always sought two things, higher sales and larger margins. That’s business after all.
Nike has been one company that seems to always deliver that combination. But this time around, that could be a challenge, one investors might not enjoy quite so much.
The company reports its first quarter of fiscal 2020 numbers after the bell tomorrow. While the company and analysts should expect solid revenue growth, they probably won’t be as pleased with the bottom line.
Costs have crept up over the last year. And with a tough year-over-year comparison framing whatever comes tomorrow, slower income growth is almost sure to catch some off guard.
In the first quarter of 2019, the company saw double-digit sales growth, accompanied by lower taxes, reduced costs and therefore higher income. In just that quarter, Nike showed 18% earnings per share growth. This is a $135 billion company. That kind of growth is rare.
With the year since then filled with even more controversy over the company’s Betsy Ross flag shoes and the boycotts they spawned, global economic slowdowns and a giant trade war, no one expects 18% again. Yet, they do somehow expect mid-single-digit growth. While not out of the question, there’s plenty of room for disappointment with that target.
The company does business all over. It is one of the most recognized brands in the world. And China is its largest growing market. However, with the economic problems there, investors should be cautious.
While most of Nike’s products have been able to avoid the ever-growing tariffs between the U.S. and China, they are very much on the brink of seeing their first share of the trade war. The round of tariffs that were eventually pushed back to December include shoes.
More than 200 companies including Nike have aggressively petitioned against it… calling the tariffs “catastrophic” in a letter to the President.
This won’t affect this most recent quarter. But you can bet it will play a huge role in what the company projects for the rest of its fiscal year.
So, even if the company is able to match the seemingly too-high analyst expectations on Tuesday, investors could still knock it on lower forecasts or flat margins.
This presents us with a perfect short-term trading opportunity. With the company up significantly this year – about 17% — even the slightest of miss or forecast let down could send shares down in a hurry.
They are unlikely to completely collapse, as the company still controls a sizable share of a still-growing market. But for option traders, there’s a way to profit without any kind of wild price swing.
A Strategy For Short Term Bears
A bear put spread is a type of options trade that involves buying one put option with a strike price near the current trading price of the underlying stock and selling a second put with a lower strike.
The income received from that sold put is used to offset some of the cost of the purchased one. This reduces the amount it takes to get into the overall trade, as well as the amount at risk.
In exchange for this offset, the maximum profit potential is capped. But for a company like Nike, with little chance of a 20% or more collapse over the next few days, this offers an ideal risk to reward situation.
You can see how this trade looks here:
Source: The Options Industry Council
Of course, the trick of using this strategy is finding the right puts to trade. You want a low enough cost and high enough profit ceiling to make it worth your while. Yet you also need to keep in mind how far the stock needs to move to hit that ceiling.
If it’s too far of a move, the whole trade could crap out and end up a loser. Fortunately, with Nike’s solid 2019 performance, we have a great opportunity with a high profit ceiling that’s not only possible… it’s very likely to play out.
Let’s get into it…
A Specific Trade on NKE Ahead of Earnings
Right now, a trader could buy October 18 $87.50 puts for $2.92 per share and sell October 18 $85 puts for $1.89 per share for a total cost of $1.03 per share. Since each put is worth 100 shares of NKE, that’s an entry cost of $103.
That $103 is the most the trader has at risk with this trade. Though, he’d only lose that if shares bounce higher from here. As noted, a disappointment is far likelier.
If earnings come in on the weak side, or at least the company’s outlook for the rest of its fiscal 2020 doesn’t meet analyst expectations, shares could easily slip a few dollars. For this trade to profit, however, they don’t need to move much.
To find the maximum potential profit of this trade, which would lock in if shares fall below that $85 strike price, take the difference in strikes ($87.50 – $85 = $2.50), and subtract the cost ($2.50 – $1.03 = $1.47).
In other words, on the 100 shares those contracts represent, the trader would be looking at a $147 profit on the $103 he put at risk… or a 143% return on his risk.
This play offers an extremely short-term and likely 143% return. Yet to lock that in, it would take little actual price movement.
Shares of Nike ended last week at $86.68. A fall to $85 is just a 1.9% price movement. Considering any miss tomorrow after the bell could result in a 5%-plus drop, this is an ideal way to play this short-term opportunity.