Here's How 'Bad News' Can Be Your Best Friend When Investing

I was a wire-house stock broker for quite a few years. Back then, when a firm's analyst downgraded a stock, it gave thousands of brokers an excuse to get on the phone to clients and get them to sell. That generated commissions and gave the brokers capital to invest back into some other, now-favored stock. Those buy orders made for even more commissions. While few firms still charge commissions on stock trades old habits die hard. There is still a slew of selling whenever analyst opinion changes are announced. Keep in mind, though, that downgrades based on opinions are not the same as reactions to real news like earnings reports, new product announcements or other company-specific news. Monday provided an example of news that isn't news. ARK Innovation ETF's fund manager raised her price target on Tesla to a whopping $3,000 per share. The stock was up 4% premarket on that touting of her largest single holding. There were no actual facts given as to why Cathie Wood chose to upgrade her goal price so spectacularly. Later that morning, Vera Bradley , one of my favorite stocks, was knocked down sharply on the reverse type of news. Cowen's analysts merely lowered the rating on VRA due to better than 193% appreciation over the past year. The stock had slightly exceeded his $12 price target recently so he was calling VRA fairly valued. I'm more bullish on VRA than Cowen's analyst. My minimum target for this year is $13.32 on this net debt-free company which is back in growth mode. After hitting $12.19 on March 16 and then suffering from the analyst downgrade blues on March 22, VRA briefly gave investors a chance to buy as low as $10.34 again. My graphics in this article reflect a snapshot price of $10.57. Buying shares in the middle $10s with the expectation of rebounding to the $13s is not a bad percentage move. My goal price is far from an upper limit. From 2012 through 2016 VRA fetched over $20 for at least part of each year. Here are two ways you can play VRA to rebound with less risk than simply buying shares outright. The graphic below showed actual pricing for VRA and some of its Nov. 19, 2021 expiration date options. Selling naked puts means standing ready to buy round lots (100-share increments) of Vera Bradley at predetermined prices, if asked to by the option owners. With Vera Bradley at $10.57, VRA's Nov. 19 $10 puts were paying $1.75 per share and its $12.50 strike price puts were fetching $3.20. Worst-case, forced purchase prices dropped to either $8.25 or $9.30 per share, respectively. That means declines of either 21.9% or 12.0% would not hurt those option sellers from now through expiration day. Upside potential from those depressed levels would, by definition, be much higher than from the $10.57 trade inception level. If VRA merely remains above $10, the more conservative option sellers would keep $1,750 per 1,000-share commitment without ever having to buy VRA at all. Maximum profit for $12.50 put writers would be $3,200 per 1,000-share commitment. Achieving that goal, however, would need to see VRA rise to at least $12.50 by Nov. 19, 2021. I see that as more likely than not. If VRA doesn't rise to that price you'd end up owning 1,000 shares, but at an average price of just $9.30. Traders had the chance to sell for $12.19 just a few days ago and was $11.99 last Friday. Nov. 19, 2021 buy/write combinations at $12.50 also look quite appealing for those bullish on VRA. A 1,000-share, 10-call plus 10-put combo is detailed below. On expiration day there are just two possible outcomes. VRA will either close at $12.50 or higher, or below $12.50. If the former situation prevails the following best-case scenario will unfold. Any upturn of at least 18.3% will translate into a stunningly good 111.1% return over just 242-days. That's 167.6% annualized. There's no guarantee that VRA will be that high next November. If not, the worst-case scenario detailed next would play out. Barring a major collapse in VRA's price, though, even that process does not seem scary. You'd end up with a double-sized position at the average cost of $9.21. That's pretty close to the same level committed to by the November 2021, $12.50 puts sellers mentioned earlier. Any drop of less than 12.8% would allow for immediate liquidation for at least a small profit. If VRA merely goes sideways and closes at the $10.57 trade inception price the net gain would be $2,720 ($1.36/share x 2,000) in the example shown. How cool would it be to make over $2,700 on a stock that went nowhere? Buying beaten-up shares of companies that are down merely due to analyst downgrades is one of my favorite things to do. On Monday, I bought more VRA shares, plus sold Nov. 2021 $10 and $12.50 puts. I'll be waiting for a bounce before selling covered calls to complete my buy/write combinations.

Here's How 'Bad News' Can Be Your Best Friend When Investing

Buying beaten-up shares of companies that are down merely due to analyst downgrades is one of my favorite things to do. Here's a great example using Vera Bradley.

Columnist Conversation

Monday Morning Fibocall for 11/29/2021

We Added to a Position in the Stocks Under $10 Portfolio

S&P Futures

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.