Good News for Cruise Lines Could Be Good For Short Term Traders
Trade summary: A bull call spread in Norwegian Cruise Line Holdings Ltd. (NYSE: NCLH) using the October $17 call option which can be bought for about $1.28 and the October $19 call could be sold for about $0.65. This trade would cost $0.63 to open, or $63 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 $63. The maximum gain is $137 per contract. That is a potential gain of about 117% based on the amount risked in the trade.
Now, let’s look at the details.
Barron’s reported that, “Cruise stocks were up strongly …, helped by a Barclays upgrade of the three largest U.S. players.”
The daily chart of NCLH shows the stock is beaten down but traders seem to be looking for a reason to buy.
Barron’s continued, “We believe we are nearing an inflection point” for the cruise industry, Barclays analyst Felicia Hendrix said in a note Friday upgrading the stocks to Overweight. “While we may be early, we believe the risk/reward is the most attractive in our coverage universe. Investors who have previously written off cruise stocks should begin to revisit their models.”
Norwegian Cruise Line Holdings (ticker: NCLH) was leading the way, up more than 7% at around $15.80. Carnival (CCL) was at $14 and change, up more than 5%. Royal Caribbean Group (RCL) was at around $63, up more than 5%.
Hendrix had downgraded the cruise industry in June but part of the reason for her upgrade is that “bookings data from each of the cruise companies has indicated pent-up demand.”
The upgrade comes at a time when the industry, mostly shut down by the pandemic since mid-March, has started to see some more positive developments.
[Recently], a panel organized by Royal Caribbean and Norwegian submitted to the Centers for Disease Control and Prevention a series of proposed health and safety protocols to resume sailings. They include wearing masks on ships and Covid-19 testing for passengers and crew before boarding, among many other measures.
The proposals made no mention of a Covid vaccine or therapeutics, underscoring the panel’s belief that cruising can resume safely without those products. The CDC, which has a no-sail order in place, is reviewing the panel’s recommendations.
“If you adopt this multi-layered approach, you can substantially mitigate the risk and create a protective bubble around a cruise experience,” Dr. Scott Gottlieb, who was co-chairman of the panel, told Barron’s this past week. He is a former commissioner of the U.S. Food and Drug Administration.
It remains to be seen, however, just how strong demand for cruising will be before a vaccine is widely available.
The cruise industry has been mostly shut down since mid-March due to the pandemic, though there have been a limited number of cruises in Europe and Asia.
Another positive development for the industry: a few cruises have resumed from ports in Italy with no report of Covid outbreaks.
Costa Cruises, a unit of Carnival, resumed a few cruises there earlier this month. And MSC Cruises, based in Switzerland, has operated a handful of cruises out of Italy as well, according to Robin Farley, an analyst at UBS.
Farley noted, however, that “demand remains limited” for those cruises so far and that it sounds like MSC’s Grandiosa ship has been operating at 40-50% occupancy. She also notes that “Costa has not had to lower price, though they are only in their 3rd week of sailing.”
“Prices for 2021 cruises are holding, since the cruise lines have no incentive to lower price this early,” she adds.
As for when the cruise industry could resume a more normal schedule of operations, Farley observes that “While it’s still early days in the restart, and improvements and cases rates could improve the outlook, some of the color on Italian demand could suggest the industry may not get much of a head start to our restart scenario.”
UBS is calling for 15% of cruise ships in service in next year’s first quarter, 35% in the second quarter and 75-80% during the second half of 2021.”
While the news is bullish, the stock is still risky after recovering little of its pandemic bear market losses.
Managing risk is important in beaten down stocks.
A Specific Trade for NCLH
For NCLH, the October 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.
An October $17 call option can be bought for about $1.28 and the October $19 call could be sold for about $0.65. This trade would cost $0.63 to open, or $63 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 $63.
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 NCLH, the maximum gain is $137 ($19- $17= $2; 2- $0.63 = $1.37). This represents $137 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $63 to open this trade.
That is a potential gain of about 117% 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 NCLH 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 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 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.