This Cash Cow Could Make Traders 150% by Thanksgiving
Options trading offers leveraged strategies that ratchet up percentage gains and lower upfront costs. Today, I’m going to show you how you could make triple-digit returns in just three months and risk as little as $ 200.
Stamps.com (NASDAQ: STMP) looks like it could be on the verge of a breakout.
As one of only three vendors licensed by the United States Postal Service (USPS) to sell stamps, the company is part of an oligopoly that includes FedEx (NYSE: FDX) and UPS (NYSE:UPS). While the latter names are strong companies, they’re more aligned with the transportation industry, while STMP is a pure play on online postage services.
The company is a virtual cash cow. The secret is its monthly subscription model, in which customers pay a fee in order to use its services in addition to postage costs. This business model works well for a company with little overhead like Stamps.com, giving it wide profit margins — over 35% in this case.
Due to the company’s online business structure, it carries no short-term or long-term debt, giving it the ability to easily make acquisitions like the $ 50 million purchase of ShipStation, an online shipping software company. The company is also doing a good job distancing itself from the USPS given the government entity’s pension liability issues and losses.
STMP trades at 13 times forward earnings with a long-term annual EPS growth rate of 20%. The price-to-earnings-to-growth (PEG) ratio compares the P/E ratio to the earnings growth rate, with 1 considered fair value. With a PEG ratio of just 0.65, STMP is growing earnings faster than its current price reflects, suggesting the stock is undervalued.
Given that the stock has taken a hit, down 22% year to date, it appears that any negatives have already been priced in. The company also has a share repurchase plan of up to 1 million shares, none of which has yet been used, which gives it plenty of room to support the stock price or make more acquisitions.
My target for STMP is $ 37 based on 2014 EPS estimates of $ 2.19 and a P/E of 17, which I think is reasonable. STMP is currently 13% below that price; however, using options, we can amplify our returns and make up to 150% on a move to that level.
Recommended Trade Setup:
– Buy STMP Nov 30 Call near $ 4
– Sell STMP Nov 40 Call near $ 0.50
– Sell STMP Nov 30 Put near $ 1.50
– Enter trade at a net debit of $ 2 or less
This idea behind this trade is to buy the call option at half price by collecting income from selling the call and put option. The strategy is known as a bull call spread with a naked leg. This is generally used when you’re bullish on a stock but buying the call is expensive.
The options premium we receive from selling the additional call and put lowers our breakeven point, but it also lowers our maximum upside gain. The downside risk is the possibility of having the short put exercised, in which case we would have to buy 100 shares of the stock at that strike price.
Our breakeven with this strategy is the strike price of the long call ($ 30) plus the net premium paid ($ 2), or $ 32. With STMP currently trading at $ 32.68, we’re already in the money.
The maximum upside potential for this trade is limited to the difference between the strike prices of the long and short call ($ 40-$ 30 = $ 10) minus the net debit ($ 2), or $ 8, giving us a gain of 300%. However, the stock is unlikely to rise that far by the third week of November, when these options expire.
A fair value estimate for STMP places it at $ 37. At this price, our gain would be equal to the stock’s price minus the short call’s strike price ($ 37-$ 30 = $ 7) minus the net debit ($ 2), or $ 5. This would still give us a 150% profit in just a few short months.
If the stock falls below our breakeven of $ 32 but remains above $ 30, then our losses are limited to the initial outlay of $ 200 — a cheap price to pay for such a high profit potential.
The downside to this trade is the possibility of the stock declining below $ 30, thus triggering our short put. If this happens, we will be obligated to purchase 100 shares of STMP at $ 30 a share for a total cost of $ 3,000 per contract. Add in our $ 200 per contract cost to enter the trade, and our breakeven point is $ 32 per share. But this isn’t necessarily a poor outcome, as we would be purchasing shares of a fast-growing company with no debt liabilities at a bargain price.