Expedia’s New Leadership Could Lead to a 114% Gain
Trade summary: A bull call spread in Expedia Group, Inc. (Nasdaq: EXPE) using the March 20 $125 call option which can be bought for about $3.05 and the March 20 $130 call could be sold for about $1.46. This trade would cost $1.59 to open, or $159 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $159. The maximum gain is $341 per contract. That is a potential gain of about 114% based on the amount risked in the trade.
Now, let’s look at the details.
Last year, Expedia Group Inc. (Nasdaq: EXPE) announced that both the chief executive and chief financial officer would be leaving the company. Now, the company is guided by Executive Chairman Barry Diller, who agreed to oversee operations until new leaders are in place.
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Diller led the latest earnings call and Market Watch reported on how one analyst viewed the call,
“While the quarter itself was somewhat disappointing, Chairman Barry Diller’s timing was impeccable, as the prior management team now gets to take the fall for the results,” Benchmark analyst Daniel Kurnos wrote in a note upgrading Expedia’s stock to buy from hold.
“Furthermore, given the transition, we expect Expedia will be given a pass for at least the next six months on things like the coronavirus or elevated expense levels, with near-term guidance also set low and a floor under the stock thanks to an aggressive share buyback.”
The upgrade came as the stock rallied.
Market Watch cited the opinion of other analysts:
- “We believe the bottom-line beat was mostly driven by Chairman Diller’s decision to eliminate wasteful marketing spend (55 basis-point improvement), and streamline operations of the company’s many unique brands,” wrote Jefferies analyst Brent Thill, who has a buy rating on the stock and raised his price target to $155 from $140.
- “While Expedia still needs to flesh out plans, its cost savings target, growth indications, and Mr. Diller’s reassuring commentary were all certainly encouraging to us,” Guggenheim’s Jake Fuller wrote. “The rough sketch that we have so far: plans include further rationalization of performance marketing, $300 million to $500 million of cost savings atop that, and what sounds like an internal refocus on core businesses.” He rates the stock a buy while raising his price target to $160 from $135.
- RBC Capital Markets analyst Mark Mahaney said that he is “somewhat cautious on Expedia arguably operating without a full-time CEO” but that he was also “fully respectful of the almost unparalleled experience Barry Diller has” in the internet sector. “Yes, we are initially skeptical – and we believe the market will be as well – of Expedia’s ability to deliver double digit Ebitda growth in 2020,” he wrote. “The good news is that this skepticism is arguably priced in… so if Expedia can actually do this, there is upside to shares.” Mahaney has an outperform rating on the stock and upped his price target to $143 from $125.
Assuming analysts are correct, this is a promising trade. The stock is moving higher from a November bottom and could quickly gain $10 or more as traders buy into the story.
But there are concerns, especially risks related to the outbreak of COVID-19, the disease brought on by the novel coronavirus, which is pressuring travel spending.
The potential risks and possible rewards make this an ideal spread trade for bulls.
Buying shares of the stock 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 EXPE
For EXPE, the March 20 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A March 20 $125 call option can be bought for about $3.05 and the March 20 $130 call could be sold for about $1.46. This trade would cost $1.59 to open, or $159 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 $159.
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 EXPE the maximum gain is $3.41 ($130- $125= $5; $5 – $1.59 = $3.41). This represents $341 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $159 to open this trade.
That is a potential gain of about 114% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying EXPE 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.
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.