Boeing Could Now Be a High Income Stock For Investors
Trade summary: A bear call spread in The Boeing Company (NYSE: BA) using July $185 call options for about $13.85 and buy a July $190 call for about $11.60. This trade generates a credit of $2.25, which is the difference in the amount of premium for the call that is sold and the call.
In this trade, the maximum risk is about $275. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($225). This trade offers a potential return of about 81% of the amount risked.
Now, let’s look at the details.
News on Boeing has been volatile, but the latest could be considered bearish as The Street noted,
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“BA has told Spirit AeroSystems (SPR) its biggest supplier of fuselage and parts for its still-grounded 737 MAX aircraft, to slash output for the third time this year, another sign the airplane maker continues to struggle with slumping demand for new planes amid the coronavirus pandemic.
In a regulatory filing, Spirit AeroSystems said it had received notice from Chicago-based Boeing that it now wants fuselages for just 37 jets through the remainder of 2020 (35 shipsets already have been delivered to Boeing) down from the 125 Boeing said it wanted in May.
The planemaker had initially told Spirit to deliver 216 this year.
Boeing, which restarted MAX production in May after a five-month pause, directed Spirit to halt work in early June before updating its expected demand for fuselages in the letter last week. Boeing communicated its updated plans in a letter June 19, Spirit said.
The directive adds additional uncertainty to an already cloudy outlook for the MAX, which has been grounded for more than 15 months in the wake of two deadly crashes believed to have been caused by malfunctioning software.
It also comes as carriers continue to grapple with the Covid-19 pandemic and dramatically reduced demand for air travel, and in turn new planes – an issue that has plagued Boeing since the pandemic took hold in North America in mid-March.
For Spirit AeroSystems it particular, it could lead to a breach of financial covenants under its credit agreement if it continues to scale back production and delivery of Boeing parts.
Some 14,000 jets, more than half the world’s fleet, have been sitting idle in the wake of unprecedented travel restrictions and now weaker demand for air travel.”
This news provides insight into BA’s plans. Decreased production could explain why the stock price has stalled.
The weekly chart appears to be showing a pattern that can be considered a dead cat bounce. Further weakness is possible.
Shorting shares of the stock to benefit from potential weakness exposes traders to significant risks in dollar terms. A spread trade with options allows traders to obtain exposure to the stock with a defined level of risk. That strategy is explained in detail below, at the end of this article.
A Specific Trade for BA
For BA, we could sell a July $185 call for about $13.85 and buy a July $190 call for about $11.60. This trade generates a credit of $2.25, 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 $225. The credit received when the trade is opened, $225 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $275. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($225).
This trade offers a potential return of about 81% 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 BA is below $185 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 $240 for this trade in BA.
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.