This Airline Could Provide a 223% Gain
Trade summary: A bull call spread in Azul S.A. (NYSE: AZUL) using the April 17 $25 call option which can be bought for about $2.07 and the April 17 $30 call could be sold for about $0.89. This trade would cost $1.18 to open, or $118 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 $118. The maximum gain is $382 per contract. That is a potential gain of about 223% based on the amount risked in the trade.
Now, let’s look at the details.
Airlines have been beaten down by the coronavirus threat, but some airlines could be due for a bounce. As PR Newswire noted AZUL, the largest airline in Brazil by number of cities served and flight departures, recently announced preliminary traffic results for February 2020.
The chart shows the extent of the recent decline.
The report offered details on passenger counts,
“Consolidated passenger traffic (RPKs) increased 25.1% compared to February 2019 on a capacity increase (ASKs) of 25.1%, resulting in a load factor of 81.2%, 0.1 percentage point higher than the same period in 2019. Domestic load factor was 81.6% and international load factor was 79.9%.
“In February we saw a growth in passenger demand matched by an equal increase in capacity. We ended the month with 40 A320neos family aircraft and four E2s, the key drivers of our margin expansion going forward”, said John Rodgerson, CEO of Azul.
In February, Azul was the number one on-time airline in Brazil, with an on-time arrival rate of 87.4% according to FlightStats.”
For comparison, on time rates for popular US airlines are below.
Azul is the largest airline in Brazil by number of flight departures and cities served, offers 916 daily flights to 116 destinations. With an operating fleet of 140 aircraft and more than 12,000 crewmembers, the Company has a network of 249 non-stop routes as of December 31, 2019.
In 2019, Azul was awarded best airline in Latin America by TripAdvisor Travelers’ Choice and also best regional carrier in South America for the ninth consecutive time by Skytrax. Additionally, in 2019, Azul ranked among the top ten most on–time low-cost carriers in the world, according to OAG.
The weekly chart shows that AZUL is near its all time low, near the levels last seen about a year after the stock began trading on the New York Stock Exchange in 2017.
A Specific Trade for AZUL
For AZUL, the April 17 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 April 17 $25 call option can be bought for about $2.07 and the April 17 $30 call could be sold for about $0.89. This trade would cost $1.18 to open, or $118 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 $118.
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 AZUL the maximum gain is $3.82 ($30- $25= $5; $5 – $1.18 = $3.82). This represents $382 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $118 to open this trade.
That is a potential gain of about 223% 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 AZUL 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.