This Might Have Been Fake News but It Creates a Possible Gain of 143%
Trade summary: A bull call spread in Norwegian Cruise Line Holdings Ltd. (NYSE: PTON) using the November $100 call option which can be bought for about $11.85 and the November $105 call could be sold for about $9.80. This trade would cost $2.05 to open, or $205 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 $205. The maximum gain is $295 per contract. That is a potential gain of about 143% based on the amount risked in the trade.
Now, let’s look at the details.
PTON was in the news for a story that that seems hard to believe. According to Barron’s,
“The threat of a well-heeled competitor gave Peloton Interactive investors a fright this past week. Competition, however, is the least of Peloton’s worries.
Here’s what happened. After the close on Monday, Echelon, a lower-priced Peloton competitor, announced that it had joined with Amazon.com (AMZN) to sell a “Prime Bike” that would cost $499.
Peloton stock fell as much as 7% on the news on Tuesday, though it finished the day down just 0.4%.” The market action is shown in the intraday chart below.
Barron’s continued, “An Amazon spokesperson said late Tuesday that the company had no formal partnership with Echelon, while Echelon CEO Lou Lentine told Fox Business that Amazon’s response was a “complete surprise,” citing conversations with Amazon in developing the bike.
Despite the fiasco, Peloton shareholders got a wake-up call—the Echelon announcement and the immediate selloff suggested the risks to Peloton stock should a true rival come along and undercut the company on price.
But, for now, the Echelon-Amazon episode highlights what Peloton has going for it: execution, brand awareness, and premium technology leadership—and why investors have been willing to award it a nosebleed multiple.
The pandemic jump-started Peloton’s path to profitability, while gyms closing helped it save money on advertising. The company’s rise could make it better-heeled to fend off smaller competitors.
Peloton recently cut the price of its flagship bike and launched Bike+, and announced plans for a more affordable treadmill.
A bevy of Wall Street analysts gushed about the announcement, as well as the company’s fiscal fourth-quarter earnings report and a higher serviceable addressable market.
Of the 26 analysts listed by FactSet, 23 are bullish. The stock’s mean price target is $152.60—implying 72% upside from recent levels.
Skeptics will have to come up with a better reason to sell than simply the specter of competition. Yes, it’s clear that if Amazon has any aspirations of committing to the digital fitness space, it could challenge Peloton. And yes, the news came a week after Apple unveiled a new $9.99 a month Fitness+ service, which should compete with Peloton $12.99 bikeless digital service.
But analysts argue that Amazon and Apple (AAPL) entering the space in effect validates its prospects. KeyBanc Capital Markets analyst Edward Yruma wrote in a note last week that Apple Fitness+ “illustrates the attractiveness of the home fitness space, but has a long way to catch up to Peloton.”
Peloton’s best analog may be Netflix (NFLX). Netflix has managed to grow despite competition from Amazon Prime Video, Disney’s (DIS) Disney+, Hulu and others.
Evercore ISI analyst Lee Horowitz believes Peloton, whose true profits will come from subscriptions for its online classes, can do the same.
“Peloton investors should refer to Netflix as a historical example in which a focused market leader in a growing digital business sees little impact from the entry of large competitors,” Horowitz writes.”
The daily chart of Peloton shows the stock’s strong uptrend as traders bought into the company’s story.
A Specific Trade for PTON
For PTON, the November 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 November $100 call option can be bought for about $11.85 and the November $105 call could be sold for about $9.80. This trade would cost $2.05 to open, or $205 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 $205.
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 PTON, the maximum gain is $295 ($105- $100= $5; 5- $2.05 = $2.95). This represents $295 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $205 to open this trade.
That is a potential gain of about 143% 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 PTON 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.