Jumia Technologies (JMIA), the “Amazon of Africa”, is up 191% since closing with a 19% 1-day, post-earnings loss on November 10th. The stock is at a 19-month high and has once again become a strong momentum trade. However, buying at these heights inherently comes with a lot of risk. At some point, the stock will cool off with a downside potential that is hard to measure except at the extremes. For example, JMIA could eventually reverse its entire breakout above the previous 2020 high around $21. Fortunately, it is possible to buy Jumia Technologies with limited risk at current prices and indeed at almost any price.
Buy With Limited Risk
A common limited risk trade involves buying shares, call options, and put options. This trade is called a “collar” and is particularly attractive for maintaining the potential for retaining ownership in the shares after the stock options expire. Its main drawback is the limited risk comes with an equivalent limited upside. At JMIA’s last close of $37.60, a well-positioned collar looks like short one December $40 call, and long one December $30 put for every 100 shares purchased. The premium from selling the calls pays for buying the puts.
At Wednesday’s close the JMIA December $40 call option sold for $5.0/$5.20, and the December $30 put sold for $2.05/$2.15. The maximum possible loss for this trade happens at $30, the strike for the put. Assuming a purchase at Wednesday’s close of $37.60, the loss on shares would be $7.60, the loss on the put would be $2.15, and the gain on the calls would be $5.0. The net loss would be $4.75 or 12.7%. Compare this to a theoretical “worst case” downside risk of 43% on a full reversal of the breakout.
The maximum possible gain happens at $45, the strike price of the call plus the premium of the call option. The gain on the shares would be $7.40, there is no gain or loss on the calls, and the puts are a loss of $2.15. The total maximum gain is $5.25 or 14.0%.
Most (swing) traders target a 3:1 reward/loss ratio so this 1.1:1 reward/loss ratio may appear poor. However, this ratio is the “price” for putting a tight limit on risk while maintaining the potential for holding the shares beyond the short-term at an effective lower price. Buying calls and puts outright come at a high cost; they are extremely speculative given JMIA’s run-up has driven a high premium into the price of options. While the risks are well-defined from an options-only position, I think the potential reward is very limited. For example, a trader needs a 20% gain in three weeks just to get even on the December $40 calls at expiration.
My path to this limited risk trade was unintended. The upward push on JMIA caught me greatly under-estimating the power of the momentum; perhaps I am still under-estimating the potential of this short-term momentum. I am a long-term holder in JMIA including some fortuitous trades around my core position. The post-earnings plunge put me on alert for the next buy-the-dip opportunity to supplement my core position. The stock stabilized within days, and I accumulated more shares.
Whatever disturbed investors and traders the day after earnings has become a distant memory as the stock now trades at an 18-month high. Given the dangers of parabolic run-ups, I went into risk management mode. First, I took profits in my supplemental shares as JMIA challenged the pre-earnings highs. JMIA went higher still. Next, I sold weekly call options with a $24 strike against my JMIA shares. I fully expected these calls to expire worthless and allow me to continue holding my core shares. This trade was very similar to what I did in the middle of JMIA’s pre-earnings parabolic run in August.
Instead, the market called away my shares as JMIA closed last week at $24.74. When JMIA jumped another 22% on Monday, I realized that I needed to return to the fray. A limited risk trade met my requirements for participating in potential upside at a lower cost. Interestingly, JMIA has not quite gone parabolic as the recent, big daily gains are relatively consistent instead of growing.
I bought 100 shares and sold a December $35 call short against it. I used some of that premium to buy a January $20 put. This configuration accomplishes two things for me: either 1) lock in a respectable profit at the December expiration, or 2) facilitate a new purchase of JMIA stock at a lower effective price. As a bonus, the January expiration extends protection on the stock in case of an extended pullback. My tolerance for loss is higher than usual given the profits I have earned in JMIA plus my perspective that lower prices provide fresh buying opportunities for what I see as a large long-term opportunity.
Be careful out there!
Full disclosure: long JMIA shares and put, short call