Bad News For This Company Could Be Good News For Traders
There are times when traders say that bad news is good news. There are several meanings for this turn of phrase but sometimes the meaning is in a literal sense and bad news for the company could provide a potential trading opportunity that is good news for traders.
Reuters recently reported,
“A federal judge in Manhattan on Friday rejected Expedia Inc’s request for an injunction that would have required United Airlines to continue providing fare data for flights after Sept. 30, when the companies’ contract ends.
U.S. District Judge Kevin Castel said Expedia had shown a “likelihood of success” on the merits of its breach of contract claim but did not show a preliminary injunction was needed to avoid irreparable harm or serve the public interest.
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An injunction would have required United, part of Chicago-based United Continental Holdings Inc, to provide Expedia with fare and schedule information for all its publicly available flights, including those after Sept. 30.
“We welcome the ruling from the judge in favor of United which will minimize the risk of disrupting our customers’ travel plans and ensure we can effectively serve customers who need to make changes to their itineraries purchased through Expedia,” United said in an emailed statement.
Expedia did not immediately respond to requests for comment.
The dispute came as some carriers try to reduce distribution costs by encouraging travelers to book directly rather than through online travel agencies such as Bellevue, Washington-based Expedia.
Southwest Airlines Co has long relied on direct bookings, and JetBlue Airways Corp in October 2017 pulled its fares from several online agencies.
Expedia accused United of trying to force a renegotiation of their 2011 contract by threatening to withhold fares for flights after Sept. 30, leaving it unable to book or change tickets.
United countered that limiting fare listings would benefit travelers flying later, because the companies’ “coming divorce” would leave Expedia unable to serve them.
In his decision, Castel found no language in the contract between Expedia and United suggesting that United would withhold fare information in the final months, and no evidence that Expedia would be unable to service customers through Sept. 30.
But he also found no proof that maintaining the “contractual status quo” would irreparably harm Expedia, even if the dispute led to customer confusion and hurt its reputation.
Castel also said the public interest did not weigh in favor of a preliminary injunction.
“There is no serious issue as to the ability of members of the public to fly on their airline of their choosing,” he wrote. “Meaningful and prominent disclosure will mitigate any harm to the public.”
There wasn’t much of a reaction to the news but the stock is in a down trend with a series of lower highs visible in the chart below.
The weekly chart confirms a bearish outlook for the stock with a recent failure at resistance setting up the latest leg down.
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.
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 EXPE
For EXPE, we could sell an April 18 $122 call for about $2.22 and buy an April 18 $124 call for about $1.20. This trade generates a credit of $1.02, 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 $102. The credit received when the trade is opened, $102 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $98. The risk can be found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($102).
This trade offers a potential return of about 104% 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 EXPE is below $122 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 $122 for this trade in EXPE.