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Global Signs of Economic Weakness

Global Signs of Economic Weakness

Investors have long understood that globalization has changed a number of opportunities. It’s even questionable as to whether global diversification helps a portfolio since there is a rising degree of correlation among stock markets around the world.

This is especially true among industries. And, that creates potential insights into the state of certain industries in the U. S. stock market. For example, airlines are affected by economic activity and that is true in every country.

Strong economic growth should result in an increase in the demand for air travel and weakness in the economy should result in at least some diminished demand for travel. That means looking at earnings reports for airlines in developing economies could lead to early insights into global economic growth.

A Sign of Trouble

It is relatively simple to monitor growth in Latin America since a number of companies from that region are traded on the U. S. stock exchanges.

One example is Copa Holdings, S.A. (NYSE: CPA). Copa provides airline passenger and cargo service through its principal operating subsidiaries, Compania Panamena de Aviacion, S. A. (Copa Airlines) and AeroRepublica, S. A. (Copa Colombia).

The company operates through air transportation segment. Copa Airlines operates from its position located in the Republic of Panama. Copa Airlines provides international air transportation for passengers, cargo and mail, operating from its Panama City hub in the Republic of Panama.

Copa Colombia provides service within Colombia and international flights from various cities in Colombia to Panama, Venezuela, Ecuador, Mexico, Cuba, Guatemala and Costa Rica. With these routes, the company is an indicator of economic activity in Central America.

When CPA announced earnings recently, Zacks reported the company “put up a disappointing performance in the third quarter of 2018 with lower-than-expected earnings and revenues.

The company’s earnings per share of $1.36 missed the Zacks Consensus Estimate of $1.42. Moreover, the bottom line plunged significantly year over year. Results were hurt by high fuel prices and weakening Brazilian and Argentinian currencies.

Quarterly revenues increased more than 2% year over year to $672.4 million but lagged the Zacks Consensus Estimate of $684.2 million. Passenger revenues inched up 1.4% year over year to $649.11 million.”

The stock sold off on the news.

CPA daily chart

Digging Deeper

There were additional signs of trouble in the earnings report. Key operational indicators for airlines all fell. From the earnings analysis, investors learned,“While passenger unit revenue per available seat mile (PRASM) slipped 4.8%, yield per passenger mile dipped 3.3%. Passenger traffic (on a consolidated basis) rose 4.8% and capacity was up 6.6% in third-quarter 2018.

Load factor contracted 140 basis points to 84.3% as traffic rise was outweighed by capacity growth.

Additionally, unit revenue per available seat mile (RASM) slid 4.2%. Operating cost per available seat mile (CASM) rose 4.3% in the reported quarter, primarily due to higher fuel costs.

However, the metric excluding fuel declined 5.5%. Cost-cutting efforts among other factors led to this upside. Average fuel price per gallon surged 31.6% year over year to $2.40.”

These trends could have been troubling investors for some time and the stock price does reflect that investors have been concerned about the company for the past year. The long term chart shown below indicates the stock has been in a down trend for months.

CPA weekly chart

But no stock goes straight down. The recent price action indicates that a small consolidation has formed, the first one in several weeks. This could attract buyers, hopeful that the stock decline is ending. Income investors could also be buying the stock’s 4.6% yield.

While the down trend is likely to resume, the short term opportunity is for the bulls, as long as risks are managed.

Trading the Trend

When a stock is expected to move higher, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.

Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up trend.

bull put spread

Source: The Options Industry Council

This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.

Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.

Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.

A Specific Trade for CPA

For CPA, a bull put spread could be opened with the December 21 put options. This trade can be opened by selling the December 21 $85 put option for about $5.95 and buying the December 21 $80 put for about $3.20.

This trade would result in a credit of $2.75, or $275 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.

The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $5 ($85 – $80). This is multiplied by 100 since each contract covers 100 shares.

Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $225 ($500 – $275).

The potential gain is about 122% of the amount of capital risked. This trade will be for about one week and the annualized rate of return provides a significant gain.

The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.

These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.