While the market is still recovering from the U.S. debt rating downgrade and higher bond yields, there are some stocks that favor this time of year.  One of those stocks just fell, giving investors a chance to get in before its best 13-week trading period of the year.  With stocks heading lower to start off August, let’s look at one that could be the strongest by the end of the month.

One stock that could stand out in a historically poor trading period is Paycom Software (PAYC).  They recently announced earnings and Wall Street wasn’t impressed, sending the stock lower by 19%.

On a weekly chart, I’m seeing a range between $300 and about $375, and with the recent pullback, it may give investors an opportune time to look at a trade that historically does well over the next 13-week period.

Before we get into that, we need to address the elephant in the room.  Earnings were stronger than expected for the online payroll and human resource technology provider.  Revenues increased from the same period a year ago as well.  The company has a history of growing earnings-per-share and sales.  They even announced a quarterly cash dividend.  

So, while some may see a 19% drop in a day as a sign to stay away, I see it as a potentially good entry point.

Over the last 10 years, Paycom has had a 90% track record of returning profits in the month of August, with an average gain of 14.1%. That’s truly impressive considering the broader Nasdaq returns an average of 1.2% with a 60% win rate in the same month.

Let’s take a look at three different options strategies you could use, assuming you believe PAYC will move up to around $350 by the end of August.

First – the put credit spread. You can sell the SEPT 15 280 put while buying the 270 put. If PAYC hits the profit target by the end of August, you’d walk away with a 99% return on investment. The trade would give you a net credit of around $285 (at the time of this writing).

Next up is the diagonal debit spread.  This is done by purchasing the 17-NOV 300 calls while selling the 15-SEP 350 calls.  The trade cost is about $2320, but if the stock rallies to the profit target, you could walk away with about $2370 in profit.

Last up is the call debit spread where you buy and sell a call in the same expiration month.  Let’s assume you buy the 15-SEP 290 calls and sell the 15-SEP 350 calls, the trade would cost you about $1790, but it has the potential to return a staggering $3100 in profits should the stock reach the profit target by the profit date.  That would be a 174% return.

Not all trade ideas are created equal. The put spread (option 1) has a higher probability of profit because the stock can move sideways or move higher for the spread to succeed. Time decay works in its favor.

The other two spreads are call debit spreads, meaning time decay works against you. The stock needs to move higher and quickly to overcome the loss in time decay.

However, in a case when you have a stock with a strong track record of moving higher over a certain period of time, I’m ok going out on a limb with capital that I’m comfortable risking. I don’t mind placing debit spreads. I’m willing to take that risk of time decay on a trade that could return 174% in a month.

It is worth noting that seasonality trends can be heavily influenced by earnings and other news-related events. For example, maybe PAYC does well in August because of a historically strong earnings report at the end of July. The correlation between a stock price moving higher and the trading month of the year does not always mean profitable trading is caused by the trading month of the year. In other words, correlation does not equal causation.

Jeff Wood
Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab

Any trade or trade idea discussed is for educational purposes only.  They will not be tracked as an official trade recommendation.