There is a certain breed of companies that has continued to perform extremely well in our rapidly evolving economy (i.e. software-as-a-service businesses that operate on a subscription basis, with high revenue growth and large total addressable markets). We write about one such company (that focuses on “dev ops”) in this report that completed its initial public offering in September, and the share price has been steadily reverting lower after an initial share price pop to more than double the IPO price. In particular we write about an attractive high income-generating options trade that also gives us a chance to pick up shares of this compelling company at an even lower price. We believe this is an attractive trade to place today—and potentially into early next week—as long as the share price doesn’t move too dramatically before then.
JFrog (FROG)
The company we are referring to is JFrong (FROG). We completed a detailed report on this newly public “dev ops” company a coupe weeks ago explaining why we like the business, and now that the share price is pulling back, we like the shares (and this trade idea) even more.
JFrog Share Price:
As we wrote in our previous report (see link above):
JFrog has consistently delivered impressive top-line and bottom-line growth in recent quarters driven by strong customer acquisition along with consistent upselling. We continue to remain impressed by the robust business model and the company’s ability to expand its portfolio offerings through research & development. While the shares currently trade at a premium, the premium has shrunk considerably in recent weeks (as the shares have reverted back towards their IPO price) and the company’s large and increasing total addressable market provides a long runway for growth.
The Trade:
Sell Put Options on FROG with a strike price of $55 (~11.3% out of the money, it currently trades at ~$62.04), and an expiration date of February 19, 2021, and for a premium of at least $2.15 (or $215 because options contracts trade in lots of 100). This comes out to approximately 3.9% of extra income just over one month—which may not sound like a big return—but it is huge for such a short time frame (it’s approximately 40% of extra income on an annualized basis, calculated as ($2.15/$55) x (365/36days)). And this trade not only generates attractive upfront premium income for us now, but it gives us a chance at buying shares of this attractive long-term company at a dramatically lower price ($55—the strike price) if the market price falls below $55 and the shares get put to us before this option contract expires in about 5 weeks. And we get to keep the upfront premium income no matter what.
Important to note, your broker will require you to keep $5,500 of cash in your account ($55 strike x 100 shares) to secure the trade (assuming you don’t want to use margin).
Also important to note, you can adjust the strike price of this trade (for example to $50) depending on how badly (and at what price) you want the shares put to you, and to generate a different amount upfront income as shown in the table above).
Your Opportunity:
We believe this is an attractive trade to place today, and potentially into early next week, as long as the price of FROG doesn't move too dramatically before then and you’re able to generate enough premium income to your liking.
Our Thesis:
Our overall thesis is simply that this is an attractive business, but it has been volatile and a bit expensive. We’d love to pick shares at a lower price (i.e. our strike price), but if the shares don’t get put to us then we’re happy to simply keep the high upfront premium income this trade puts in our pocket. And in addition to the detailed report about FROG we have provided, here is a look at the average FROG price target (dotted line) according to the 10 Wall Street analysts covering it and reporting to Factset (i.e. they believe the shares have significant near-term upside).
Important Trade Considerations:
Two important considerations when selling put options are ex-dividend dates and earnings announcements because they can both impact your trade. In JFrog’s case only earnings is a concern (because it doesn’t pay a dividend). Regarding earnings, JFrog is expected to “announce” sometime around February 4th (before our options contract expires), and this adds uncertainty and potential volatility to our trade. However, the upfront premium income on this trade is so high, that we feel adequately compensated for the volatility risk.
Conclusion:
JFrog is an attractive business, but like many recent IPO’s the share price has been volatile. It’s often wise to wait before buying new IPOs because share prices often revert much lower after an initial “IPO pop” as has been the case for JFrog. We really do like the business as a long-term investment, and some readers may consider simply purchasing a few shares outright. However, the trade described in this report puts a high amount of upfront income in your pocket right away (that you get to keep no matter what) and it also gives you a chance to pick up shares of this attractive business at a lower price if they fall below the strike price and get put to you before the options contract expires.