Small-cap growth stocks have been taken to the woodshed over the past year as the Federal Reserve has embarked on the most aggressive monetary tightening effort since the days of Paul Volcker. A slowing domestic and global economy has also provided a negative backdrop to these types of names.
Some small-cap companies with good long-term growth prospects have lost 60%, 70% and even more than 80% of their market value over the past several quarters. In retrospect, this sector was obviously overvalued in the previous long-term era of easy money provided by the central bank. However, many of these names now seem clearly oversold.
Using simple covered call strategies can give investors the confidence to slowly accumulate names like this while providing significant downside protection. Remember, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Today, we will look at two new small-cap stocks I am starting to build positions in with covered call orders in my own portfolio.
I teased Upwork Inc. (UPWK) in my column on Wednesday. The company operates the largest online work marketplace in the country and plays a critical role in the growth of the virtual workforce as it is a key intermediary for clients that are looking for skilled freelancers.
The stock has lost nearly 80% of its value over the past year. However, the company is delivering consistent revenue growth in the low 20s and should turn the corner into profitability in 2023. Upwork's balance sheet is in good shape and the company recently affirmed third-quarter guidance.
With the stock trading at under three times forward sales estimates, I like the long-term risk/reward in UPWK at these levels.
Upwork Option Strategy:
This is how one can execute a covered call position in UPWK. Using the April $12.50 call strikes, fashion a covered call order with a net debit in the $9.60 to $9.80 a share range (net stock price - option premium). This strategy provided downside protection of just over 20% with nearly 30% upside potential even if UPWK stock does nothing over the next six months.
Our second small-cap growth name is Sprinklr, Inc. (CXM) . The stock is down some 50% over the past year.
Sprinklr develops and provides enterprise cloud software products that help provide customer-based analytics across channels. Two-thirds of the Fortune 100 use its products. Subscription revenues rose 29% on a year-over-year basis in the second quarter and Sprinklr has similar longer-term sales growth to Upwork.
This summer, company management significantly reduced its net loss projection for this fiscal year and Upwork looks like it will break even for the first time next fiscal year. Sprinklr, also has over $500 million of net cash on its balance sheet. Accounting for that, CXM, similar to UPWK, trades at just under three times forward sales projections, which gives it an attractive risk profile at current price levels.
Sprinklr Option Strategy:
This is how one can execute a covered call position in CXM. We are going to select a call strike at a dollar lower than current trading levels for additional downside protection.
Using the May $7.50 call strikes, fashion a covered call order with a net debit in the $6.10 to $6.30 a share range (net stock price - option premium). This strategy provides downside protection of just over 25% with 20% upside potential even if this stock trades down $1 a share over the next seven months.
