Last week, I explained how an options strategy known as a “short straddle” can be used to make money from a stagnant stock. A short straddle entails selling both a call and put option on a stock using the same strike price and expiration date.

This week, I am going to explain how to use a “long straddle” to profit from a stock that is likely to move strongly one direction or the other. A long straddle is created by purchasing both a call and put option on a stock using the same strike price and expiration date.

To illustrate, I will revisit a company I wrote about last fall when Kyndryl Holdings (NYSE: KD) was divested from International Business Machines (NYSE: IBM). IBM no longer wanted to be saddled with its gradually diminishing services business so it spun it off as a new company.

I was not a fan of Kyndryl as an investment. I said then, “Wall Street doesn’t like businesses with declining revenue streams. Eventually, the cost of running the business consumes all of the net income.”

I was right about that. Last week, you could buy KD for around $10. That’s an 80% decline from where it opened for trading less than ten months ago.Last week, Kyndryl released its fiscal 2023 Q1 results. The first bullet point of the press release was less than encouraging: “Revenues for the quarter ended June 30, 2022 total $4.3 billion, net loss is $250 million, pretax loss is $205 million and adjusted pretax loss is $50 million.”

Normally, a company leads off with the most impressive operating metric for the quarter and hides the bad news further below. In this case, there was no impressive operating metric to cite.

Low Expectations

Despite the paucity of good news in Kyndryl’s quarterly report, Wall Street reacted as if the company hit it out of the park. That day, KD jumped nearly 2% and then added on another 1.5% after the market close.

You know expectations are low for a company when a $250 million loss is reason to celebrate. However, that also makes me wonder how the stock might perform if the company one day has some good news to report. Kyndryl’s CFO, David Wyshner, implied as much:

“Our transformation is well under way. I’m encouraged by the execution throughout our organization on our Alliances, Advanced Delivery and Accounts initiatives. These efforts put us on track to achieve our medium-term goals, including sustained top-line growth, stronger margins and higher returns on invested capital.”

That last statement begs the question; how long is medium-term? Under the heading ‘Recent Developments’ the company notes that it “signed contracts tied to cloud hyperscalers alliances with an aggregate value of $235 million, progressing towards it $1 billion hyperscalers signings target for fiscal 2023.”

The company also claims that it has “generated annualized savings of roughly $100 million as of quarter-end, equal to half of Kyndryl’s fiscal 2023 year-end objective.” Kyndryl also states that it improved accounts with substandard margins by “$52 million of annualized benefits, on track to achieve the company’s $200 million fiscal 2023 year-end goal.”

In terms of guidance, Kyndryl reaffirmed its outlook for “double-digit constant-currency signings growth compared to pro forma signings in calendar year 2021.” It is also anticipating “revenue of $16.3 to $16.5 billion,” and “adjusted pretax margin of 0% to 1%, consistent with calendar year 2021 pro forma results.”

Sink or Swim

Now that Kyndryl has put those stakes in the ground, Wall Street can easily measure the extent to which it lives up to them (or not). If it comes in better than that, KD could quickly rally above $15. But if it comes up short then it could just as easily sink below $5.

That brings me back to my long straddle trade on Kyndryl. Last week while KD was trading at $10.40, the call option that expires next March at the $10 strike price could be bought for $2. The same put option could be purchased for $1.50 for a total cost of $3.50.

For this trade to be profitable, KD must rise above $13.50 or drop below $6.50 within the next seven months. If it remains within those boundaries then I’d lose money on this trade.

I have no idea which way it will go, but my gut tells me that it is going to move strongly one way or the other over the next three quarters. By then, it should become clear if Kyndryl can make it on its own or is destined to fail.

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