Shares of General Electric (NYSE:) are up more than 21% to date and 112% in the past 12 months. Shares of the industrial giant, which hit a multi-year high in early March, are currently hovering at $106. The 52-week range was $47.44 – $115.32.
Despite the price hike over the past year, Wall Street is still optimistic about the company in the long run. According to 19 analysts surveyed by Investing.com, the average 12-month price forecast is $122, representing a return of approximately 15.5%.
Chart: Investing.com
Still, investors paying attention to technical charts will note that there is resistance between $105 – $110 – a level the stock must clear before making another attempt at $115 and above.
So today we look at how moderately bearish investors might consider putting together a bear put spread on GE stock. Investors who expect the next move in GE stock to be lower can benefit from such a strategy.
It may also be appropriate for long-term investors to use this strategy in conjunction with their long equity position. The setup could provide some short-term protection against a potential price drop in the coming weeks. ]. General Electric had been a member of the blue chip index for over a century.
Since then, management, led by CEO Lawrence Culp, has cut costs, reduced debt and worked to return to its industrial roots. The group currently focuses on four core segments: healthcare, aviation, electricity and renewable energy.
On July 27, GE issued Q2, which pleased investors. Revenue grew 9% year over year to $18.3 billion. However, it was still below pre-pandemic levels. As a result, adjusted earnings per share came in at 5 cents, compared to an adjusted loss of 14 cents a year ago.
Wall Street noted that all four segments improved year-over-year earnings. Since 2018, management has worked to improve balance sheets and reduce total debt by a whopping $70 billion. In June, General Electric had just $64 billion in outstanding debt.
Culp said about the results:
"… our operating margins increased in all segments and we generated positive industrial free cash flow. Momentum is growing in our businesses, driven by healthcare and services in general, with aviation showing early signs of recovery."
Management increased the full-year industrial free cash flow (FCF) guidance to a range of $3.5 billion to $5 billion, up from previous guidance of between $2.5 billion and $2.5 billion. $4.5 billion. The company expects adjusted earnings per share for the year to be in the range of 15 to 25 cents. GE shares are currently trading at 52.2 times future earnings, indicating a potentially overextended valuation level.
Bear Put Spread On GE Stock
Readers who believe there could be a little more profit taking in general In the short term, electric stocks might consider adopting a bear put spread strategy to start.
As we noted, it may appeal to investors who are already long GE stocks. A 'bear put spread' would offer some protection against a fall in prices in the short term.
This transaction requires a trader to have one long General Electric put with a higher strike price and one short GE put with a lower strike price. Since both puts have the same expiration date, the spread is vertical.
Such a bear put spread would be established for a net debit (or net expense). It will benefit if General Electric's stock falls in price. As we write, GE stock is trading at $106.01.
The trader could buy an out-of-the-money (OTM) put option, such as the GE Dec.17 100-strike put option. This option is currently offered for $4.83. So it would cost the trader $483 to own this put option, which expires in about three and a half months.
At the same time, the trader would sell another put option with a lower strike price, such as the GE Dec.17 90 strike put option. This option is currently offered for $2.13. Therefore, the trader would receive $213 to sell this put option.
Since the premium received for selling the lower strike price (i.e. $90.00 here) is less than the premium paid for the higher strike price (i.e. $100.00 here), the result is a net -depreciation.
The trader wants to see the price of the GE stock fall, ideally with a closing price – at the time of expiration – that is equal to or lower than the lower strike price (ie $90.00 here).
Risk/Reward Profile for Unaudited Bear Put Spread
The maximum risk of this trade would be equal to the cost of the put spread (plus commissions). In our example, the maximum loss would be ($4.83-2.13) X 100 = $270 (plus commissions).
This maximum loss of $270 can be realized if the position is held to maturity and both GE puts expire worthless. Both puts will expire worthless if the stock price at expiration is higher than the strike price of the long put (higher strike price), which is currently $100.
The maximum potential profit from this trade is limited to the difference between the strike prices (i.e. ($100.00-$90.00) X 100) minus the net cost of the spread (i.e. $270) plus commissions.
In our example, the difference between the strike prices is $1,000. Therefore, the profit potential is $1,000-$270 = $730.
This trade would break even at $97.30 on the day of expiration (excluding brokerage commissions).
Bottom Line
Wall Street is bullish for GE stock in the long run, a view we share. In the short term, however, profits can be taken on the shares, leading to fluctuations and a price decline.
When investors take a stake in stocks, they make the decision to accept a certain market and business risk. A strategy such as a bear put spread can help reduce some of that risk at certain times of the year.
It is understandable that, depending on a trader's opinion, a different expiration date and/or a different pair of strike prices may also be chosen. Traders must have a realistic price forecast and understand the risk-return profile of each trade set. In other words, they have to make trade-offs.
Interested readers may wish to improve their understanding of options and possibly talk to a financial advisor to see if options are right for their portfolios.
