Saudi Arabia’s Money Could Highlight a 63% Gain for Investors
Trade summary: A bull call spread in Carnival Corporation & Plc (NYSE: CCL) using the May 15 $12.50 call option which can be bought for about $2.15 and the May 15 $15 call could be sold for about $1.20. This trade would cost $0.95 to open, or $95 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 $95. The maximum gain is $155 per contract. That is a potential gain of about 63% based on the amount risked in the trade.
Now, let’s look at the details.
A look at the chart offers ample reasons to be bullish on CCL.
Prices formed a double bottom. Stochastics, a popular momentum indicator shown at the bottom of the chart formed a small bullish divergence as price fell and then completed a bullish crossover. Any of these factors could justify a buy on their own.
But there is also news. As SFBJ reported,
“Saudi Arabia’s Public Investment Fund became the third-largest stakeholder in Carnival Corp. [recently].
The government-controlled investment fund purchased 43.5 million shares of common stock in the cruise company, according to a filing with the U.S. Securities and Exchange Commission (SEC). Any stock purchase of more than 5% of a company’s shares must be reported with the SEC.
The purchase gave Saudi Arabia an 8.2% stake in Carnival Corp., whose nine cruise brands and more than 100 ships make it the world’s largest cruise company.”
At the same time, Carnival “launched 78.9 million new common stock shares … in an attempt to grow its liquidity as the travel industry struggles to cope with the effects of the coronavirus pandemic.
The company’s largest shareholder remains Chairman Micky Arison. [He] served as CEO of the company from 1979 to 2013.”
Finally, the company “closed its private offering of $1.95 billion in convertible senior notes due in 2023. Carnival expects to close on an additional private offering of $4 billion in senior secured notes on Wednesday.
All together, the company wants to grow its cash reserves by about $6 billion to help it weather the storm as its cruise ships sit vacant at ports worldwide. Many of Carnival’s brands have suspended voyages into mid-May.”
The long term chart using weekly data is shown below. It highlights the fact that there is risk in the trade since the bullish signals come after the stock fell sharply.
A spread trade offers the opportunity to gain substantial exposure to meaningful gains while strictly limiting risk.
A Specific Trade for CCL
For CCL, the May 15 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 May 15 $12.50 call option can be bought for about $2.15 and the May 15 $15 call could be sold for about $1.20. This trade would cost $0.95 to open, or $95 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 $95.
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 CCL the maximum gain is $1.55 ($15- $12.50= $2.50; $2.50 – $0.95 = $1.55). This represents $155 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $95 to open this trade.
That is a potential gain of about 63% 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 CCL 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 CCL 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.