This Reopening Story Could Deliver a 157% Gain
Trade summary: A bull call spread in Eldorado Resorts, Inc. (NYSE: ERI) using the July $40 call option which can be bought for about $4 and the July $45 call could be sold for about $2.60. This trade would cost $1.40 to open, or $140 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 $1.40. The maximum gain is $360 per contract. That is a potential gain of about 157% based on the amount risked in the trade.
Now, let’s look at the details.
As the economy reopens, traders will have the chance to profit as operations exceed expectations or disappoint investors. In early reports, it appears that consumers are spending, and gaming stocks could be among the winners.
In a recent Business Wire news release, ERI announced the” planned resumption of operations at five properties in Florida, Indiana, Colorado and Ohio, pending receipt of final regulatory approvals.
Eldorado plans to reopen Isle Casino Racing Pompano in Florida on June 13, Tropicana Evansville in Indiana on June 15, Isle Casino Hotel Blackhawk and Lady Luck Casino Blackhawk in Colorado on June 17, and Eldorado Gaming Scioto Downs in Ohio on June 19.
Upon these reopenings, 21 of Eldorado’s 23 casino entertainment facilities will have reopened following the suspension of operations in March.
Anthony Carano, President and Chief Operating Officer of Eldorado Resorts said, “We are excited and grateful to be on track to reopen our casinos in Florida, Indiana, Colorado and Ohio very soon, following which 90 percent of our properties will have resumed operations.
As we reopen our facilities across the country, the health and safety of our Team Members and Guests remains our priority. We have been working very hard over the last two months to prepare to welcome our Guests back and look forward to safely providing the outstanding service and hospitality experiences our casinos in Florida, Indiana, Colorado and Ohio are known for.”
Eldorado Resorts is a leading casino entertainment company that owns and operates twenty-three properties in eleven states, including Colorado, Florida, Illinois, Indiana, Iowa, Louisiana, Mississippi, Missouri, Nevada, New Jersey, and Ohio. In aggregate, Eldorado’s properties feature approximately 23,900 slot machines, VLTs and e-tables and approximately 660 table games, and over 11,300 hotel rooms.
The stock appears to be bouncing off short support and positioned to challenge recent highs.
The longer-term chart using weekly data shows the recent pullback ended near a potentially important long term support level. This level was tested and held several times in 2019.
There are still significant risks of a broad sell off in the stock market and a spread trade can significantly reduce risks while providing for upside potential.
A Specific Trade for ERI
For ERI, the July 19 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 July 19 $40 call option can be bought for about $4 and the July 19 $45 call could be sold for about $2.60. This trade would cost $1.40 to open, or $140 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 $140.
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 ERI, the maximum gain is $3.60 ($45- $40= $5; 5- $1.40 = $3.60). This represents $360 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $140 to open this trade.
That is a potential gain of about 157% 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 ERI 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 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.