Shares of this streaming TV platform have fallen 50% since July, and the stock now trades at a compelling price relative to its long-term value. However, for those of you that like high upfront income (and are real sticklers on price), the trade described in this report is worth considering. The trade strategy sounds complex (i.e. “bullish vertical put spread”), but it’s not. It puts attractive upfront premium in your pocket today, it gives you a chance to pick up shares of this attractive stock at a lower price, and it gives you a little insurance on the downside (i.e. your max loss is limited). We believe this is an attractive trade to place over the next few trading sessions, as long as the share price doesn’t move too dramatically first.
Roku (ROKU)
(Purple Line: Roku share price)
The stock we are referring to is Roku (ROKU). For those of you that don’t know, it is an extremely rapidly growing streaming TV platform. Viewers either buy a Roku stick to add to their TV or approximately a third of all TVs sold in the US come with Roku already installed. And what is so important about Roku is that streaming TV is a HUGE market opportunity. Smart TVs gather all kinds of data based on watching habits, and that data is EXTREMELY valuable to advertisers. Said differently, Roku’s business is extremely valuable.
We’ll get into the details of our trade thesis in a moment, but first… the trade…
The Trade: “Bullish Vertical Put Spread” on Roku
Sell AND Buy Put Options on Roku (ROKU) with a strike price of $205 (sell) and $170 (buy), and an expiration date of December 17, 2021 (roughly 1 month away), and for a net premium (upfront cash in your pocket) of approximately $2.03 (or $203 because options contracts trade in lots of 100). Your broker will make you keep $3,500 cash on hand (($205 - $170) x 100 (assuming you don’t want to use margin). The trade generates +5.8% of extra income over the next 1 month ($203/$3500). And this trade not only generates attractive income for us now, but it gives us the possibility of owning shares of attractive Roku at an even lower price if the shares fall even further than they already recently have, and they get put to us (and we’d be happy to own Roku (as a long-term investment), especially if it falls to a purchase price of below $205 (it currently trades around $240) but above $170 (if it falls below $170 we’d take the cash difference between our $170 strike put and the market price at expiration—this is basically insurance)). The trade may sound complicated, but it’s not, and your broker likely makes all the calculations and execution easy as you can see in the graphic below.
*Important Note: You will have to “work” this trade a bit as market prices and premium dollars are dynamic and constantly shifting. The goals is to select strike prices and premiums you are comfortable with, such as those we have described above.
Your Opportunity:
We believe this is an attractive trade to place today and over the next few trading sessions as long as the price of Roku doesn't move too dramatically before then, and as long as you’re able to generate premium (income for selling, divided by put sale strike price) that you feel adequately compensates your for the risks (currently 5.8% over the next 1 month).
*Note: premium income available increases when market volatility increases, as it just has for Roku as the shares have recently sold off.
Our Thesis: Roku (ROKU)
Our thesis is simply that we believe Roku is an extremely attractive long-term business (thanks to its leadership position, high growth rate and the massive market opportunity), and we’d be happy to pick up shares at the lower price of $205. Roku shares sold off hard following the most recent earnings announcement, and this is a continuation of the sell off that has been happening since July. However, this combined selloff is an overreaction, and the shares are now significantly underpriced relative to the company’s long-term value.
Roku’s earnings announcement earlier this month was largely positive, but the company provided slightly lower forward guidance which resulted in analyst downgrades and the share price sell off accelerated (as you can see in our earlier price chart). However, the analyst and market reaction is too short-term focused (as it almost always is) as the company’s long-term growth and profitability trajectory remain intact as you can see in the following chart.
Specifically, the above chart is busy, but Roku’s forward growth rate remains high, profitability remains strong and the valuation (on a price-to-sales basis) is now more attractive. As such, we’re happy to pick up the upfront income on this trade, and we’re happy to own Roku shares for the long-term if they get put to us before this options contract expires in a month.
Important Trade Considerations:
Two important considerations when dealing with options contracts are earnings announcement dates and dividends. However, neither are a significant factor in this case because Roku does not pay a dividend, and because the company will not announce quarterly earnings again until after this contract has already expired. If their was an upcoming earnings announcement or dividend (before this options contract expired) we’d have to adjust our trade to be comfortable with the added price volatility of those events.
Conclusion:
When shares are weak in the short-term (as Roku has been in recent months) volatility and fear are higher, and this causes the upfront premium income available in the options market to increase. And this has created an attractive trading opportunity, especially considering Roku remains a very attractive business in the long-term (despite the recent share price weakness). In our estimation, these shares will eventually go much higher in the long-term considering its impressive growth trajectory and massive ongoing market opportunity.
Regarding the trade in this report, if the shares do get put to us at $205—that’s great—and we look forward to hanging on for the long-term. And if they don’t get put to us, we’re happy to keep the upfront premium income that this trade generates for us (we get to keep that income, no matter what). Furthermore, not only do we have a little insurance on this trade (we put/sell the shares at $170 if they fall below that level before the options contract expires), but the insurance piece also lets us enter this trade with a lower amount of cash set aside than if we just sold naked puts (for example, we’d have to keep $20,500 of cash in our account—to “cash secure” the trade—if we sold naked puts with a strike price of $205). The big risk is that the shares fall all the way below $170 and we sell at that level. However, there are lots of ways to win. We like this trade and we like Roku as a long-term investment—especially if we get the shares at a lower price.
Note: Our previous “bullish vertical put spread” options trade (on Facebook) expires on Friday. The trade was successful. It appears highly likely the shares will not be put to us, and we’ll simply keep the high upfront premium income that trade generated.