GM’s Earnings Beat Not Enough

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Despite ongoing trade tensions and plenty of negative press, General Motors (GM) is having a rather stellar year.

The company recently reported its second quarter earnings. It met sales estimates but blew away analysts’ earnings expectations… again. This marks the fourth straight quarter of positive earnings surprises.

But not all is going so well. We’ve recently seen a slew of headlines about the shuttering of U.S. factories for the company. GM may be beating analyst expectations handily, but that doesn’t mean those expectations were all that great to begin with.

Sales continue to slip. The biggest reason is China. That’s no surprise. But the amount is staggering. Last year, 44% of GM’s sales came from the country. The only thing holding it afloat is new vehicle launches. But it can only launch so many new SUVs and trucks into a market that’s quickly becoming saturated with competition.

And then, of course, the newest blow… another round of tariffs. While GM has already been embattled with the Trump Administration over previous tariffs, this new round announced late last week signal that they aren’t going away anytime soon.

These new ones don’t directly impact GM as the old ones do. But China’s retaliation surely will. The Chinese central bank announced over the weekend that it is letting the tightly-held currency exchange rate between the yuan and the U.S. dollar slip. Meaning, China is actively weakening its currency.

For a U.S. company that relies so heavily on sales in the currency, that weaker yuan will have a significant impact on the company’s bottom line going forward.

The Fed’s recent rate cut now takes on a different shape. If we enter a currency war with China on top of the tariff wars, there will be no greater loser than GM.

It relies too heavily on its overseas sales. And no number of earnings beats can fix that.

As you can see, investors initially sent shares up after its numbers were released last week. But that was the same day Trump announced his new round of tariffs.

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Since then, GM’s stock has continued falling. But looking back to its full 2019 performance, it’s clear it has plenty of room left to decline.

That presents a great short-term opportunity. For GM’s shares to start trading at a more reasonable price range, they’d have to fall another 10% or even 15% from where they are right now. That, however, might not happen overnight. The one thing we can be fairly confident in, however, is that they won’t rise anytime soon.

So, one way to play this situation is to simply short GM’s stock and wait it out. That, however, can be costly and unfruitful for quite a while.

Instead, there’s an options strategy to benefits from both sideways and downward price movements. It’s far cheaper and comes with very limited risk.

Let’s get right into it…

A Strategy For Short Term Bears

A bear call spread is a type of options trade that involves selling a call option on a stock you believe is set to show weakness in the near term and buying a second call option with a higher strike price to limit your risk.

This produces a net credit for your account. That is the total profit potential of the trade. But it is yours as long as shares don’t go up. Meaning, shares don’t even have to fall for you to profit here.

The second call option limits how much you have at risk. If shares do rise, you aren’t risking your whole portfolio with this trade.

The risk is capped at the strike price of the bought call option. You can see how this kind of trade works here:

OIC Profile

Source: The Options Industry Council

As you can see, the potential profit is capped. But so is the risk. That makes this an extremely conservative way to play a stock that you expect will decline in the coming weeks and months.

For GM, there’s no better way to play it. Let’s look at a specific example…

A Specific Trade For GM Bears

Right now, a trader can sell a September 20 $39 call option for $1.28 per share and buy a September 20 $40 call for $0.85 per share for a net credit of $0.43. Since each represent 100 shares of GM, that’s a total income of $43 hitting the trader’s account right up front.

That $43 is the maximum he stands to make on the trade. However, to keep that full amount, shares of GM don’t have to move a penny. He keeps it even if they don’t fall as expected as the currency and trade wars between the U.S. and China continue to escalate.

The risk too is locked in right up front. To find that, take the difference in strike prices ($40 – $39 = $1), and subtract the credit ($1 – $0.43 = $0.57). Again, on 100 shares of GM, that’s a $57 in total risk.

In other words, the trader is looking at a return (that’s in his pocket right up front) of 75.4% on the amount at risk. And he would keep that full return so long as GM shares do nothing.

Since they remain overvalued right now, and the rhetoric remains tense between the world’s two largest economies, the chance of flat-to-falling share prices for this company that remains beholden to both of them is quite likely.

A trade like this doesn’t come around often.

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