Trades

This Hot Stock Just Got Hotter

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When you think of 2019’s year-to-date rally in stocks, you probably think technology firms and high-flying cannabis stocks. But there’s another smaller group of stocks that have exploded so far this year – and have been for even longer: financial services.

The specific ones we’re talking about are financial transaction plays: Mastercard and Visa on the traditional side and PayPal and Square on the even faster-growing tech side. These companies have been on fire.

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As you can see, each of these have jumped between 20% and 40% in just the first four months of 2019. And after the most recent earnings announcements from all of them, it seems like there might not be an end in sight.

Each turned in double-digit growth during the first quarter. Though, it should be pointed out that Square is yet to actually turn a profit.

The argument is a global one. While it might be cliché to even discuss it these days, there are many people around the world that are moving up to middle class status. Credit cards, checking accounts, electronic payments and so on are becoming more and more common. Mastercard just announced a $1 billion investment in India to build a new center for business there and in surrounding countries, for example.

As if that’s not enough, we’re seeing this growth continue quarter after quarter for different reasons… especially for the latter two of these plays, PayPal and Square. More and more transactions are taking place online.

This trend is only picking up. These two companies are seeing their numbers of users and transaction volumes grow at astronomical rates.

While Square might have the more interesting story of these two, PayPal has a more profitable story to tell.

You see, PayPal has a weapon up its sleeve the rest of these financial transaction companies don’t. It has Venmo.

Over the last year, the number of transactions through PayPal’s mobile payment service Venmo jumped 70%. The company now states that more than 40 million people use the service. The reason this isn’t driving PayPal up even faster than its competitors is because the company hasn’t been able to monetize it yet. But it will.

The company has already told investors it plans to start that process soon.

In fact, there’s a very good chance we’ll see substantial progress on this front soon, at least before the end of the year.

Of course, PayPal isn’t putting all of its eggs in one basket. The company itself has undergone a rebirth or at least heavy restructuring.

Last year, PayPal sold off its credit portfolio to Synchrony Financial. This $7.6 billion deal put cash in PayPal’s pocket, reduced the risk and heavy portfolio of debt and allowed it to get back to focus on its core business. Now, this deal was fruitful to both sides. Synchrony got exclusive rights to the PayPal brand in that business. So, we’re not declaring a winner. But PayPal looks sharper today than a year ago.

Investors have rewarded the company’s decisions on these fronts, as noted with its large share price rise over the last several months.

But you could easily argue that the company has much higher to climb.

During just this last quarter, the company blew away earnings estimates by 15%. Its EPS of 78 cents during the quarter also represents a massive 37% increase year over year. Remember, this company is already a $127 billion industry leader. So, that kind of growth is nearly unheard of.

But there’s more to this story than just a compelling bottom line growth rate. It was able to continue growing its top line despite losing a major revenue stream from the previous comparable period.

PayPal reported top-line growth of 12% year over year. That’s impressive itself. But consider that with its credit portfolio still intact, that rate would have been 19%.

That’s small-cap sized growth. Mega companies like this one don’t usually perform so well, especially after spinning off such a large segment as its credit portfolio was. Instead, it took the $7.6 billion in cash to grow the rest of its business, which we’ve already seen is a risk worth taking.

There’s significant room to grow here. The catalyst for explosive growth would come from monetizing Venmo. But even if that’s delayed to later in the year, there’s a real short-term profit opportunity here.

Let’s look at a strategy to play that.

A Strategy For Short Term Bulls

A bull call spread is a type of options trade that involves buying a call option with a strike near the current price of shares and selling a second call option with a higher strike price.

This results in a small net debit, but can offer large profit potential. You can see the tradeoff here:

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Source: The Options Industry Council

While the sold call reduces the cost of the trade, it does cap the potential profit. But with some uncertainty remaining over the timing of Venmo monetization, that’s worth it in this case.

In fact, with so much recent build up in share price, PayPal options offer a near perfect bull call spread opportunity.

Let’s look at a specific example.

A Specific Trade in PYPL

Right now, a trader looking to use this strategy to get in on PayPal’s explosive growth could buy a July 19 $110 call for $4.30 per share and sell a July 19 $120 call for $1.17 per share for a net debit of $3.13 per share. Since each represent 100 shares of PYPL, that’s an entry cost of $313.

Now, the trader couldn’t lose any more than that amount in the whole two and a half months this trade is open. But he could profit a lot more if shares continue to rise.

If shares do keep going up at the rate they have been, hitting $120 isn’t out of the question. In fact, most analysts have targets in the $130s range. So, even if they only rally half as high as the experts expect, this trade looks great.

To find the maximum profit potential here, take the difference in strike prices ($120 – $110 = $10) and subtract the entry cost ($10 – $3.13 = $6.87). Again, on 100 shares, that’s $687.

Think about that. As long as PayPal keeps doing what it has been so far this year – not even counting what could happen if it monetizes Venmo early – this trade would return $687 on the $313 at risk. Or, in other words, it could return 219% on the amount at risk.

It also comes with a relatively long-time frame. So, this jump wouldn’t have to come all at once. With the current trajectory of PayPal’s share price movement, this is a no brainer.

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