Shopify stock appears to be finally gaining back its momentum.
The company, which provides a cloud-based, multi-channel commerce platform that assists businesses in selling products and services, has been taking advantage of the artificial intelligence theme by rolling out several related features.
Shopify Dashboard, which is available in more than 20 languages, enables merchants to manage products and inventory, process orders and payments, build customer relationships, and leverage data analytics.
The Ottawa, Canada-based company forecasted Q3 revenues well above analysts’ estimates after its last report, signaling confidence in the current operating environment. Shopify is set to report third-quarter results next Tuesday before the opening bell.
Shopify Earnings and Stock Performance
Shares of Shopify SHOP, which are currently a Zacks Rank #1 (Strong Buy), have lagged the market this year, but that could change in swift fashion before the end of December. The company has exceeded the earnings mark in eight consecutive quarters. SHOP stock has begun to display relative strength, rising above key technical levels:
StockCharts
Image Source: StockCharts
Back in August, Shopify reported second-quarter earnings of 26 cents per share, representing a 30% surprise over the $0.20/share consensus estimate. The e-commerce platform provider has delivered a trailing four-quarter average earnings surprise of 31.2%.
Analysts covering SHOP stock are in agreement and have been raising their fiscal 2025 earnings estimates lately. Next year’s EPS estimates have been increased by 0.76% in the past 60 days. The Zacks Consensus Estimate now stands at $1.33/share, translating to an 18.6% growth rate relative to current year. Shopify continues to innovate and find ways to accelerate growth.
Zacks Investment Research
Image Source: Zacks Investment Research
Option Essentials
While there are many ways to take advantage of this bullish move, options provide us with flexibility, enabling us to tailor our strategy to the current market environment.
When done correctly, trading options provides huge profit opportunities with limited risk making options one of the most versatile investment vehicles.
Before we analyze today’s trade, let’s review some option fundamentals as a refresher. There is no need to worry about complex mathematical formulas or equations. Over the years I’ve found that the more complicated a strategy is, the less likely it is to work over the long run.
Options are standardized contracts that give the buyer the right – but not the obligation – to buy or sell the underlying stock at a fixed price, which is known as the strike price. A call option gives the buyer the right to buy a particular security, while a put option gives the buyer the right to sell the same. The investor who purchases an option, whether a put or call, is the option buyer, while the investor who sells a put or call is the seller or writer.
These contracts are valid for a specific period of time which ends on expiration day. There are weekly options, monthly options, and even LEAPS options which are longer-term options that have an expiration date of greater than one year.
Option spreads can be an extremely effective strategy. Debit spreads are implemented by purchasing a call option and selling a related call option with a higher strike price. These types of trades are limited risk trades because the short option is ‘covered’ by the option purchase.
Below we’re going to explore a call option spread strategy.
The Power of Option Spreads
Shopify currently meets our criteria for initiating a bullish call option spread position. SHOP stock has entered a renewed uptrend and is breaking above critical levels. The company is witnessing positive earnings estimate revisions, which our research has shown to be the most powerful force impacting stock prices.
The table below displays the risk/reward profile for this trade. SHOP is trading at $83.96/share at the time of this writing. This trade involves purchasing the December 70-strike call at 15.7 points (yellow box), and selling the December 80-strike call (gray box) at 8.7 points for a total cost of 7 points. As option contracts represent 100 shares of the underlying security, this would translate to a total cost of just $700 per spread (orange box).
Zacks Investment Research
Image Source: Zacks Investment Research
The top (blue) row in the lower section shows the performance of SHOP stock based on different percentage scenarios at expiration. The last (purple) row shows the corresponding percentage return for our debit spread trade. We can see that regardless of whether SHOP increases in price, remains flat, or even loses 2.5% from our entry, our option spread trade will produce a 42.9% return.
These are types of odds I like to have in my favor when trading options.
Advantages of Spread Trading
1) The Option Sale Provides Downside Protection
The sale of a call option results in cash being credited to your brokerage account. This reduces the cost basis of the option purchase and provides downside protection in the event the price of the underlying stock declines.
2) Risk is Reduced
In the SHOP trade just presented, the sale of the 80-strike call reduced the risk of the 70-strike purchase from $1,570 to just $700 per contract.
3) Allows Us to Maintain Positions During Volatile Markets
The downside protection provided by the call option sale helps us maintain our spread trade during heightened volatility. Naked option purchases may force us to sell early in order to prevent large losses.
4) Spreads Can Be Profitable If Stock Goes Up or Down
Option spreads can be profitable even if the underlying stock decreases or remains flat, providing us with an entirely new dimension of money-making opportunities.
Remember that the call option sold through this strategy profits as the price of the underlying stock declines, providing us with a cushion during market pullbacks.
Option spreads are a safe way to use the leverage inherent in options. Your risk is limited to the price paid for the spread. The call option spread strategy is an excellent way to take advantage of the bullish move in SHOP shares ahead of the upcoming earnings announcement.
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