Up on Capitol Hill and across trading rooms on Wall Street, discussions over the enforcement of antitrust laws have entered frenzy mode. Google, Amazon and Facebook all face long roads over just how big they can become.
Microsoft remembers this well. In the late ‘90s, it too faced a similar legal challenge. Though it survived, it took a hit for a time. Facebook now controls four of the five most-downloaded mobile apps. Amazon continues to increase its reach and market dominance. And Google, as ever, completely rules its domain.
But another tech giant has taken a different path over the last several months and years. Following its spinoff from former parent eBay, PayPal Holdings (PYPL) has chugged along as one of the fastest growing and least viewed tech stocks in the market.
The company’s performance has been other worldly, with quarterly and annual growth consistently above 20% and innovations in the financial services field to successfully compete with the likes of Visa and Mastercard. It’s done all this while trimming its own nonessential businesses, like its leftover credit portfolio last year.
As you can see, investors have rewarded this hyper growth and nimble management:
From the start of 2019 until now, the company has more than doubled the S&P 500’s tremendous performance with share price growth of more than 40%. That’s a $140 billion company that’s been able to do that. Few see such startup stage growth at this size.
But all good things must come to an end. At least, that’s what some investors are thinking today.
Yesterday, after the bell, PayPal announced its second quarter numbers. While earnings beat analysts’ estimates, revenue missed. Worse, the company lowered its own full-year guidance. Shareholders have dumped its stock today, sending it down a few percentage points for the first major downward move of the year.
Of course, generalizing a company’s past and projected performance like this doesn’t do it justice… especially for a high-growth play like PayPal.
The revenue miss this past quarter came from both currency issues and a faster-than-expected roll off from its exclusive partnership with eBay. The two companies – former parent and child – will have a complete break in 2021.
However, that was all known. Investors are just upset that so much happened this most recent quarter. As Lisa Ellis of MoffettNathanson noted, 2020 and 2021 will show a much “smoother transition” from eBay’s exclusive partner.
What investors seem to be overlooking this quarter was PayPal’s ongoing business performance. Overall volume of payments rose 24%. As more and more transactions go through PayPal‘s systems rather than traditional financial transaction services companies, that puts more and more money in the company’s coffers.
Its ace in the hole, Venmo, also had a stellar period with volume growth of 70% to $24 billion. As has been reported in the past, this newer service could become a real moneymaker for the company in years going forward. Right now, PayPal is waiting to monetize it. But that day will come when all of those Venmo users will mean real cash flow for the company.
All of this is to say that the second quarter was actually pretty good for PayPal. It is meeting its targets, growing the right businesses and has a high-growth path forward.
As for that path, its lower guidance shows that instead of 16% to 17% revenue growth in 2019, it now targets a rate range of 14% to 15%. By no means is it showing that the financial servicer is turning into a slow, mature company just yet.
So, this one-day retreat in share price opens up a short-term trading opportunity. While investors are still placing bets on momentum plays like PayPal, its shareholders should look at today’s dip as just a brief profit taking. Shares should continue to their march higher over at least the next few months.
So, instead of $120 per share, investors can now get in for a few bucks less. But there’s a better way to play this short-term bounce opportunity.
A Strategy For Short Term Bulls
A bull call spread is a type of options trade that involves buying one call option and selling a second one with the same expiration date but a higher strike price.
What this does is reduce the amount of cost of the trade… and therefore the amount at risk. The income from the sold call offsets a portion of the cost of the first one. This reduces the money at play, but it does give up some potential upside.
You can see how this trade works here:
Source: The Options Industry Council
As you can see, the cost is reduced and capped… but so is the maximum potential profit. While PayPal has many months of growth ahead of it, it won’t likely double overnight any time soon.
So, this strategy works for short term bulls that have a set target price in mind. Considering recent price action, a target of $125 over the next two months isn’t out of the question.
Let’s look at a specific trade with that target to see how this strategy would work best for PYPL.
A Specific Trade in PayPal
Right now, a trader could buy a September 20 $115 PYPL call for $4.92 per share and sell a September 20 $125 call for $1.13 per share for a total of $3.79 per share. On 100 shares, that’s a total net debit of $379.
That’s the total at risk with this trade. If PayPal does linger where it is trading post earnings for two full months, that’s what the trader would lose.
But the more likely outcome would be a return to growth, as shareholders finish taking profits. And if that does happen, the rewards far outweigh the risk.
To find the maximum potential profit, take the difference in strike prices ($125 – $115 = $10), and subtract the cost ($10 – $3.79 = $6.21). Since each option contract represents 100 shares of PYPL, that’s a potential return of $621.
In other words, if PYPL returns to form and continues to perform well over the next two months, the trader would see a 164% return on the amount he put at risk.
Now, shares would have to clear the $125 price point to lock in that full return. But that’s a rise of just 7.5%. Consider the 40%-plus rally in the first half of this year and the one-day discount right now, that’s on the table.
In fact, PYPL shares would have to just reverse today’s decrease and have one more good day over the next two months to achieve that. That’s more than doable.