Trading vs. Investing
From Our July 2016 E-mail Archives: Our Head Trader, Robb, replied to an e-mail from one of Maverick's traders who asked Robb for his thoughts on a trade idea.*
-----Original Message-----
From: Brian R.
Subject: Re: Market Foundations - Check
Hello Robb,
I just wanted to check in and get your thoughts on a trade idea. My wife and I went to Cabo for 10 days the week y'all went to Vegas for the annual Maverick Summit, then ended up moving mid-June. Our new home required some renovations, which has distracted me from my training a bit, but I am back progressing through my simulator trades and am about halfway through Maverick's training on range-bound patterns.
At work, we are looking at converting some of our platforms to SAP. Not sure if you're familiar with them, but I thought I would check out their stock as I know they have systems globally. Turns out they may be a decent candidate for some range-bound strategies.
Obviously, I'm not through the options training yet, so I have not looked that deep into them, but the chart pattern looks interesting to me. Volume might be a bit light for your taste from what I am learning from your videos, but thought I would send it your way to get your thoughts. Is this the kind of pattern I am looking for?
Thanks for all you guys are doing at Maverick, Robb. I wish I'd found you about 3 years ago.
No rush, my friend.
Brian
-----Reply Message-----
Hi Brian,
Thanks for the extra time. We just got back from Cabo as well and had a great time down there. Now, back to business...Haha.
I think SAP looks great on a chart as you have a nice break-out last week (off what I assume was an earnings report) with nice, bullish volume.
Whenever I see a break-out where the stock spent a lot of energy to break out (about a 13-14% move over the last 2 weeks), I typically see some consolidation above the break-out point ($82) to give the stock a chance to catch its breath and build energy for another move.
So, my stock outlook for the next few weeks would be a 0 (neutral) and my outlook for the next few months would be a +1 to +2 (mildly to moderately bullish). This is the setup that I like to use a Diagonal Call Spread on since I get to sell an August 85.00 short-term call for $1.30 and buy either the September 80.00 or 82.50 (I would probably choose the 82.50, which is trading for $3.60). Overall, the total net debit (and risk) of the trade would be $2.30.
Here are few of the possible outcomes:
- If the stock takes off and goes higher over the next few weeks, then you would probably have about a $0.90-$1.00 profit – or a 30% return for 4 weeks.
- If the trade goes sideways on the August expiration, then the 85.00 will expire, you will keep the $1.30 and you will get to make a decision on the September 82.50 whether to hold or sell. My rule is that if I still like the trade and would enter it on that option expiration, then I keep the long call. If not, then I close the entire position for a small gain/break-even.
- The perfect scenario would be to close just below $85 on August expiration and then take off to $90+ after that, giving us both a profit on the Short Call (August 85.00) and the Long Call (September 82.50).
- The worst case scenario would be a loss of $2.30.
I say that if you are trading, then everything is simply a ticker symbol and a price. What the company does – earnings, management, etc. – doesn’t matter AT ALL. In trading, the only thing that matters is trend and price.
Investing has everything to do about those things – earnings, management, etc. – and, in the end, has not as much to do about price, although you do want to use some measures to make sure you aren’t overpaying for assets. If you are looking at SAP as an investment, then you need to look out in the future to economic cycles, technology cycles and earnings/revenue growth. SAP has grown its revenues nicely over the past five years. However, as you can see, the earnings have been flat for the most part.
This tells me that the company is growing, but is investing much of the profits back into the business, which is quite bullish overall. I did make sure that there wasn’t an unusually high dividend since sometimes when you see this revenue growth with no earnings growth, it’s because they are either paying it all out to shareholders or buying back company stock. In this case, SAP has a 1.5% dividend and share count has been steady. So, overall, the fundamentals of the company are quite bullish and SAP saw revenue growth of +15%, which is generally very bullish.
The last thing in fundamentals is to make sure that you aren’t paying too much as far as price-to-earnings (P/E). SAP’s Trailing P/E is 25 and Forward P/E is 17, which are both likely in the normal ranges for a technology company growing at +10%. Thus, you could make the case fundamentally that the stock is “cheap” compared to historical valuations. However, as we teach in Market Foundations, what SAP does over the next 1-10 years is going to be determined by what the markets overall do over that period. If we have a bear market or two in the next five years, then we would expect that SAP will either go lower or flat. If we have a bullish economy, then SAP is looking like a stock that will do well in that environment.
Sorry for the long response, but you hit a sensitive spot since we at Maverick Trading don’t like to blend trading and investing like they do on CNBC, Fast Money, etc. “Trading” is trying to make money off a stock’s movement only. “Investing” is making money by buying a piece of the pie (shares) and having the entire pie get bigger (thus, making some money on it). Treat "Trading" and "Investing" as entirely different animals and you will do better in your trading and also better in your investments.
Thanks,
Robb
* NOTE: Some original wording may have been modified for legibility and/or clarification.
