Social Media and Photo Messaging Platform Snap (NYSE 🙂 is known for its popular network app Snapchat. SNAP shares are up a whopping 370% in the last 12 months. On February 24, they hit a record high of $ 73.59.
Now the stock is hovering around $ 57. It is a momentum stock. On April 6, Atlantic Equities upgraded the company from "neutral" to "overweight".
In the social media field, Snap faces competition from Facebook (NASDAQ :), Twitter (NYSE :), Pinterest (NYSE 🙂 , as well as TikTok— a subsidiary of the Chinese parent company ByteDance whose ecosystem extends well beyond TikTok.
In 2014, Facebook wanted to acquire Snap for $ 3 billion, but the group declined the offer. Then Snap made its stock market debut in March 2017 at an IPO price of $ 17.
The company is expected to publish its first quarter earnings by the end of April. That's why we're looking at Snap today and giving the example of a covered call on the company's stock.
Over the past few weeks, we have discussed how investors might consider writing covered claims for their holdings.
Such an option strategy could help reduce the volatility of their position and provide shareholders with some protection against possible declines in the share price. Readers new to options may want to revisit the first article in the series before reading this post.
Snap
Intraday Price: $ 57.15
52 Week Range: $ 11.32 – $ 73.59
Price change 1 year: Up about 370%
California-based Snap announced the fourth quarter and full year 2020 in early February. Quarterly sales were up 62% year-over-year to $ 911 million. Daily Active Users (DAUs) were 265 million in Q4 2020, up from 47 million, or 22% year-on-year. Investors were pleased with the robust revenue and user growth.
Non-GAAP net income was $ 136.1 million versus $ 41.9 million in Q4 2019. Diluted non-GAAP earnings per share was 9 cents. A year ago it was 3 cents. Cash and cash equivalents amounted to $ 2.5 billion.
CEO Evan Spiegel said:
“We are proud of the strong results we delivered for our advertising partners this quarter and throughout the year. We delivered our first full year of adjusted EBITDA profitability and, as we look to the future, we are excited to build on our investments in augmented reality, mapping and content to drive our continued growth. "
In the first quarter of 2021, management expects sales of between $ 720 and $ 740 million, compared to $ 462 million in the first quarter of 2020. The P / B and P / S ratios of Snap shares are 35.32 and 31.44 respectively. Given the massive rise in the Snap stock price over the past 12 months and the frothy valuation, there could be volatility with a downward trend around the upcoming earnings release date. So a covered call may be a suitable strategy for some investors.
Covered Calls On SNAP Stock
For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date. date sometime in the future.
At the time of writing Intraday Tuesday, Snap was trading at $ 57.15. That's why we'll use that price for this post.
A stock option contract on SNAP (or any other stock) is the option to buy (or sell) 100 shares.
Investors who believe that short-term profits could be taken soon, could use a somewhat in-the-money (ITM) covered call. A call option is ITM if the market price (here $ 57.15) is higher than the strike price ($ 55.00).
Thus, the investor would buy (or already own) 100 SNAP shares for $ 57.15 and simultaneously sell a May 21, 2021 SNAP call option with a $ 55.00 strike-strike. This option is currently being offered at a price (or premium) of $ 6.75.
A buyer of an option would have to pay $ 6.75 x 100 (or $ 675) in premium to the seller of the option. This call option will stop trading on Friday, May 21, 2021.
This premium amount belongs to the option writer (seller) no matter what happens in the future, for example on the day of the expiration date.
The 55.00 strike offers more downside protection than a phone call for money (ATM) or out-of-the-money (OTM).
Assuming a trader would now participate in this covered call trade for $ 57.15, at expiration the maximum return would be $ 460, i.e. ($ 675 – ($ 57.15 – $ 55.00 ) x 100), excluding trade commissions and fees.
Risk / Reward Profile for Uncontrolled Covered Call
The maximum profit of an ITM covered call is equal to the extrinsic value of the short call option.
The net asset value would be the tangible value of the option if it were exercised now. Thus, the intrinsic value of our SNAP call option is ($ 57.15 – $ 55.00) X 100, or $ 215.
Extrinsic value is the difference between the market price of an option (or its premium) and its intrinsic price. In this case, the extrinsic value would be $ 460, i.e. ($ 675 – $ 215). Extrinsic value is also called time value.
The trader realizes this $ 460 profit as long as the price of SNAP stock at expiration remains above the strike price of the call option (i.e., $ 55.00).
At maturity, if the stock closes below the strike price, the option would not be exercised, but would instead expire worthlessly. Subsequently, the shareholder with the covered call position receives the shares and the money (premium) that he / she paid for the sale of the option.
At maturity, this transaction would break even at a SNAP stock price of $ 50.40 (i.e. $ 57.15 – $ 6.75), excluding trading commissions and fees.
Another way to think of this breakeven price is to subtract the call option premium ($ 6.75) from the underlying SNAP stock price when we initiated the covered call (i.e. $ 57.15).
On May 21, if SNAP shares close below $ 50.40, the transaction would start to lose money within this covered call setup. Thus, by selling the covered call, the investor has some protection against a potential loss in the event of a fall in the underlying stock. In theory, the price of a stock could drop to $ 0.
What if SNAP Stock Hits a New Record?
As we noted in previous articles, such a covered call would increase the upside profit potential. The risk of not fully participating in the potential appreciation of the SNAP stock would not appeal to everyone. However, within their risk / return profiles, others may find that acceptable in exchange for the premium received.
For example, if the SNAP stock hit a new high in 2021 and closed at $ 80 on May 21, the trader's maximum return would still be $ 460. In that case, the option would be deep ITM and likely exercised. A brokerage fee may also be charged if the shares are called away.
As part of the exit strategy, the trader could also consider rolling this deep ITM call option. In that case, the trader would buy back the $ 55.00 call before it expired on May 21.
Depending on his / her views and objectives regarding the underlying SNAP stock, he / she might consider initiating a different covered call position. In other words, with an appropriate strike, the trader could potentially roll out to a June 18 maturity call.
Bottom Line
SNAP stock has been on fire for the past year, and we are optimistic about the company over the long term. With a market cap of approximately $ 83 billion, the social media platform has even more room for growth. However, earnings season typically means greater volatility for such momentum stocks. The initial reaction to tech stock gains could easily be “not strong enough” in the past quarter or outlook.
The exact timing in the marketplace at which SNAP shares could take a breather is difficult to determine, even for professional traders. But options strategies provide tools that can prepare for sideways moves or even price declines, especially around the earnings release date.
We consider covered call options as a possible way to generate additional income from your equity portfolio. Such a strategy also helps reduce portfolio volatility. Interested investors might consider expanding their knowledge base.
