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Trades

Opportunity Arises From an Investor Misunderstanding

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Uninformed investors can make the simplest of mistakes. Often, a little research and factchecking can go a long way to making significant money in both the short term and long.

Today, we have just such a situation with UnitedHealth Group Inc. (UNH).

Likely you are aware, UNH is one of the country’s largest health insurance providers, with more than 49 million people using its plans. But you might not know just what those plans are.

First, let’s back up a moment. Right now, the conversation in the healthcare world is all about the 2020 presidential election. The Democrats are fielding dozens of candidates – many discussing “Medicare for All” policies.

This isn’t necessarily an argument about how likely that is. But it does play a role in any investment decision about a health insurance company.

The idea is that with healthcare costs rising faster than nearly every other monthly expense in most people’s budget, something needs to be done. The government, as you know, has a major role in this discussion. Insurers like UnitedHealth are at the center of this debate.

President Trump failed to get an Obamacare repeal bill signed into law earlier in his presidency. He still views this as important and crucial. But he’s decided to wait until after the 2020 election.

The thing is… under the American Care Act, or Obamacare, insurers are doing just fine. In fact, the until next year, it still mandates you buy insurance or risk a fee on your taxes.

A full repeal – through either legislation or in the courts – won’t make U.S. insurance laws any less friendly to insurance companies. They did just fine before ACA was ever introduced.

But Medicare for All, that’s something entirely different… for some.

You see, the idea behind Medicare for All is to put all U.S. citizens on the current Medicare plans seniors in this country enjoy. There are various ways the candidates propose doing that… and the cost of it varies depending on the source’s political allegiance. But the premise is to move people over from private and employer-based insurance plans to a government-backed one.

This sounds like a disaster for insurance companies. While there will surely be supplemental private insurance, the industry would still face impossible revenue cuts.

But not all insurers are created equal. And Medicare, in any likely form, won’t be the end-all, be-all of health coverage even if these policies make it into law… which itself wouldn’t be for another two-plus years.

UnitedHealth reported its first quarter earnings this week. And with all of the talk about fears in the insurance industry and a slowing economy, one part of it sticks out like a sore thumb… one few investors seem to be picking up on.

Important Note From UNH’s Earnings

UnitedHealth has seen both its top and bottom lines grow in perfect stairstep fashion over the last few years:

Screen Shot 2019-04-19 at 4.30.11 AM.png

This latest quarter, despite the whirlwind of negative press for insurance companies, saw very much the same results. Revenue jumped $3.5 billion and net income rose $633 million.

Yet, investors have remained bearish… even after these excellent results:

Screen Shot 2019-04-19 at 4.30.21 AM

There was one more piece to this release that caught our eye, however. Nearly half of the company’s total revenue comes not from employer-based plans or personal ones… but from Medicare itself. The very thing that’s supposed to wreck this industry.

Medicare, as you likely already know, does not cover everything. It does not cover all screenings, surgeries, drugs and other necessary parts of regular healthcare. For that, seniors can elect to pay for Medicare Advantage… and for prescriptions, Medicare Part D. And to do so, they have to go through companies like UnitedHealth.

In fact, UnitedHealth is the single largest company that provides these specialty plans. In just the first three months of this year, UNH made $21.1 billion off these plans. It covers 25% of the entire market, as a matter of fact – more than any other.

So, with the threat of Medicare for All years away and not as painful even if passed for the likes of UnitedHealth, now’s a great time to play this uninformed investor situation. Many have been shorting and buying puts on shares of UNH of late, especially around this week’s earnings announcement. As they leave, more informed investors should send shares back up.

Fortunately, there’s a great strategy for that…

A Strategy For Short Term Bulls

A bull call spread is a type of options trade that involves buying a call option on a stock you believe will go up and selling a second call on it to offset a lot of the cost.

This means that both the total amount at risk and potential return are capped. But with a company that likely will go up, but not soar to brand-new heights, it makes the perfect risk-reward setup.

You can see how this type of trade works here:

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Source: The Options Industry Council

A bull call spread offers returns as the underlying stock rises in value up to the strike price of the sold call option. The downside, as you can see above, is also limited at the total amount to enter the trade.

This is a conservative, yet lucrative way to leverage short price movements for a company like UnitedHealth. Let’s look at a specific example to see just what we’re talking about here.

A Specific Play on UNH

A trader looking to use this strategy to play a post-earnings bounce could buy a June 21 $220 call for $10.95 per share and sell a June 21 $230 call for $6.15 per share for a cost of $4.80 per share. Since each represent 100 shares of UNH, that’s a net debit of $480.

That might sound like a lot. But hold on for the potential return. To find that, take the difference in strike prices ($230 – $220 = $10), and subtract the entry cost ($10 – $4.80 = $5.20)… or $520 total.

This means that if United does return to share prices it traded for at the start of April at any time between now and June 21, the trader could be looking at a return of 108% on the amount at risk.

With so much misunderstanding here – like just how much the Democratic healthcare proposals would affect companies like UnitedHealth and how likely any of this is in the near term – there’s a distinct profit opportunity.

The rewards outweigh the risk, and there’s time to see it bring in a triple-digit return without much movement in UNH shares. This is about as good as it gets for options traders.

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