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A New CEO Could Deliver a 71% Short Term Gain

A New CEO Could Deliver a 71% Short Term Gain

Stocks often react to news. This was the case recently when a stock dipped on news that a CEO who led a turnaround would be stepping aside. However, that news could create a trading opportunity as traders reconsider their opinions. Benzinga reported, “United Airlines (NASDAQ: UAL) said Dec. 5 it is promoting President Scott Kirby to succeed Chief Executive Oscar Munoz, effective May 20.

Munoz, 60, a former railroad executive who took United’s reins in September 2015 and recruited Kirby, 52, from American Airlines, will transition to the role of executive chairman of the board for a one-year term.

“With United in a stronger position than ever, now is the right time to begin the process of passing the baton to a new leader,” Munoz said in a statement. “One of my goals as CEO was to put in place a successful leadership transition for United Airlines. I brought Scott to United three years ago, and I am confident that there is no one in the world better equipped to lead United to even greater heights.”

Munoz, with Kirby’s help, implemented a turnaround strategy two years ago that has led to significant improvement in United’s operational and financial performance. The board’s decision indicates its support of management’s direction.

United post a strong third quarter, with net income growing 23% to $1 billion. For the first nine months of 2019, net income grew 43% to $2.4 billion. Last year, United set internal records for most revenue passengers flown, mainline departures and fewest cancellations.

As part of this transition, United’s current chairman, Jane Garvey, will retire in May 2020 after more than a decade on the board. At the board’s request, she had remained in her role for a year beyond the board’s mandatory retirement age.

Munoz was supposed to become chairman under his original contract, but after video of a passenger being dragged off a flight at Chicago O’Hare International Airport went viral, the board decided to keep the top roles separate.

“Oscar became CEO at one of the most challenging points in United’s history, and his focus on putting customers and employees first has transformed United’s culture today and successfully positioned the company for tomorrow. One of Oscar’s greatest legacies is the best-in-class leadership team he has built, and we have full confidence that Scott is the ideal candidate to lead United into the bright future that lies ahead,” Garvey said.

Munoz took over an airline struggling with integration problems since its 2010 merger with Continental. Then-CEO Jeff Smisek had been removed after a federal probe into whether he authorized favors to personnel at the Port Authority of New York/New Jersey to secure slots at Newark International Airport.

Critics questioned United’s decision in 2016 to hire someone without any experience running an airline, although Munoz had served on the board of Continental and United Continental.

Munoz got off to a rocky start after leaving Class I railroad CSX Transportation, where he spent 12 years, including nearly four years as chief operating office. He previously held executive positions at AT&T, U.S. West and Coca-Cola. Less than two months after his appointment at United, Munoz suffered a heart attack. He eventually received a heart transplant and returned to work in early 2016. During that period, United fended off Wall Street activists looking to exert more control over the company.

But he was quickly able to win employee confidence, instill a culture of customer service and reliability and build up the domestic route network.

United confirmed this week that it plans to buy 50 Airbus A321XLR aircraft to expand its reach into Europe. The airline plans to upgauge aircraft on certain domestic routes to increase operating efficiency.”

The stock dipped slightly on the news.

UAL daily chart

However, the pattern remains bullish on the longer-term chart with UAL near its recent highs and the dip could be a normal retracement from resistance.

UAL weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying UAL could require a significant amount of capital and exposes the investor to standard risks of owning a stock.

To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.

Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.

To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.

This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.

UAL bull call spread

Source: The Options Industry Council

Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for UAL

Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

For UAL, the January 17 options allow a trader to gain exposure to the stock.

A January 17 $90 call option can be bought for about $2.26 and the January 17 $92.50 call could be sold for about $1.34. This trade would cost $0.92 to open, or $92 since each contract covers 100 shares of stock.

The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $92.

The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.

For this trade in UAL the maximum gain is $1.58 ($92.50 – $90= $2.50; $2.50 – $0.92 = $1.58). This represents $158 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $92 to open this trade.

That is a potential gain of about 71% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.