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An Analyst Change Could Set Up a Big Trading Opportunity

An Analyst Change Could Set Up a Big Trading Opportunity

Analyst changes can affect the price of a stock. This makes sense because the analyst can be among the outside observers who know the most about the company and their opinions can carry a great deal of weight with investors.

This applies to both upgrades and downgrades in the outlook of well respected analysts. A recent example, as Benzinga reported can be seen in the news associated with Carnival Corp (NYSE: CCL).

Carnival recently reported second-quarter earnings of 66 cents per share, which beat the analyst consensus estimate of 61 cents. This is a 2.94% decrease over earnings of 68 cents per share from the same period last year.

The company reported quarterly sales of $4.84 billion, which beat the analyst consensus estimate of $4.53 billion. This is a 11.09% increase over sales of $4.357 billion the same period last year.

Carnival shares are trading lower, however, after the company cut FY2019 earnings per share guidance from $4.35-$4.55 To $$4.25-$4.35, citing geopolitical and macroeconomic headwinds affecting the company’s Continental European brands.

Benzinga noted that “Wedbush analyst James Hardiman maintained a Neutral rating on Carnival and lowered the price target from $54 to $50.”

The reasoning behind the downgrade was also explained,

“Continental Europe continues to weigh on Carnival’s yield outlook, Hardiman said in a [recent] note.

“Given the underperformance of Carnival shares since the company’s 4Q report, we have wanted to get more constructive on the name, and yet the company’s outsized exposure to continental European passengers and the resulting disappointing yield guidance makes the Carnival 2019 story a tricky one,” the analyst said.

Wedbush’s lower price target represents modest upside from current trading levels, but not as much upside as Royal Caribbean Cruises Ltd (NYSE: RCL) or Norwegian Cruise Line Holdings Ltd (NYSE: NCLH), Hardiman said.

“The yield growth guidance coming out of 4Q18 represents a disappointment at the time, with hopes that management was being exceedingly conservative. The unchanged yield guidance following 1Q and this 100 basis reduction adds insult to injury, underscoring just how serious the European issue appears to be for CCL.”

This news may have contributed to strong selling in the shares of the company.

Carnival daily chart

The stock is now down near an important support level and a break of that level could trigger even more selling, potentially pushing the price lower.

Carnival weekly chart

A Trading Strategy To Benefit From Weakness

A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.

In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.

Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.

One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.

Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.

The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.

bear call spread

Source: The Options Industry Council

While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.

You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.

Every day, we scan the markets looking for trades that carry 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.

A Bear Call Spread in CCL

For CCL, we could sell a July 19 $45 call for about $2.45 and buy a July 19 $47.50 call for about $0.85. This trade generates a credit of $1.60, which is the difference in the amount of premium for the call that is sold and the call.

Remember that each contract covers 100 shares, opening this position results in immediate income of $160. The credit received when the trade is opened, $160 in this case, is also the maximum potential profit on the trade.

The maximum risk on the trade is about $90. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($160).

This trade offers a potential return of about 77% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if CCL is below $45 when the options expire, a likely event given the stock’s trend.

Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $90 for this trade in CCL.