Classic value investor, Warren Buffett, and successful growth investor, Cathie Wood, both have significant positions in this very attractive non-US fintech company. And this year’s volatility and share price weakness/volatility has given rise to an attractive high-income-generating options trade. We implemented a highly successful similar trade on this stock back in June, and conditions are again attractive for a similar income-generating options trade.
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 today—and potentially over the next few trading sessions—as long as the underlying share price doesn’t move too dramatically before then.
StoneCo (STNE)
The stock we are referring to is StoneCo (STNE), a Brazil-based fintech company that provides retail merchants with electronic payment and short-term financing related solutions to manage their businesses across in-store as well as online channels. Its target customers primarily include micro, small, and medium-sized businesses across several industry verticals in Brazil. The company also provides services to nearly 260 integrated partners including global payment service providers, independent software vendors, and digital marketplaces, who embed StoneCo’s payment solutions into their own offerings to enhance the user experience.
One of the things we really like about this business is that is has high revenue growth and high margins (both gross and net margins), as you can see in the chart below (all the way to the left is STNE).
The charts ranks many of the top revenue growth stocks in existence, and unlike most of them--StoneCo's business is actually very profitable (as per the high margins. We'll have A LOT more to say about this business later in this report, however first some comments on the price (and then the trade).
StoneCo shares have been soft this year (see share price chart below) after last year’s incredible strength following the pandemic, and this has created an outstanding high-income trading opportunity.
The Trade: “Bullish Vertical Put Spread” on StoneCo
Sell AND Buy Put Options on StoneCo (STNE) with a strike price of $52.50 (sell) and $35 (BUY), and an expiration date of August 20, 2021 (roughly 22 days away), and for a net premium (upfront cash in your pocket) of at least $0.85 (or $85 because options contracts trade in lots of 100). Your broker will make you keep $1,750 cash on hand (($52.50 - $35) x 100 (assuming you don’t want to use margin). The trade generates ~4.9% of extra income over the next 22 days ($85/$1750). And this trade not only generates attractive income for us now, but it gives us the possibility of owning shares of attractive StoneCo 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 StoneCo, especially if it falls to a purchase price of below $52.50 (it currently trades around $57.83) but above $35 (if it falls below $35 we’d take the cash difference between our $35 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.
*Note: Depending on how badly you want to own the shares of this stock, and how much upfront premium income you want to generate, you can adjust the strike prices on this trade. For example using a $55 strike (instead of $52.50) should significantly increase the upfront premium income, and it also increases the chances that these shares get put to you.
Your Opportunity:
We believe this is an attractive trade to place today and potentially over the next few days as long as the price of StoneCo 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 4.9% over the next 22 days).
Our Thesis: StoneCo (STNE)
Our thesis is simply that we believe StoneCo is a very attractive long-term business, and we’d be happy to pick up shares at the lower price of $52.50, especially considering the share price has been floating lower this year (from a high of around $95) as the pandemic trade unwinds. Regardless of the near-term price action/volatility, StoneCo remains a very attractive long-term investment. And you can read our previous full report pasted at the end of this article.
Important Trade Considerations:
Two important considerations when dealing with options contracts are earnings announcement dates and dividends. Dividends are not an issue (because STNE doesn't pay a dividend), however the company is scheduled to announce earnings on (or around) August 11th--which is before our options contract expires. This adds uncertainty and volatility to our trade, but it is also part of the reason the premium income available is high and attractive. We are comfortable with the earnings announcement uncertainty on this trade.
Conclusion:
When shares are weak in the short-term (as StoneCo has been in recent months as the pandemic trade unwinds) 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 StoneCo 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 market opportunity (as we have explained in our earlier report link).
Regarding the specific trade in this report, if the shares do get put to us at $52.50—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 $35 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 $5,250 of cash in our account—to avoid using margin—if we sold naked puts with a strike price of $52.50). The big risk is that the shares fall all the way below $35 and we sell at that level. However, there are lots of ways to win. We like this trade and we like StoneCo as a long-term investment—especially if we get the shares at a lower price.