UAL Offers A Potential Double-Digit Gain
Trade summary: A bull call spread in United Airlines Holdings, Inc. (Nasdaq: UAL) using the September $36 call option which can be bought for about $2.90 and the September $40 call could be sold for about $1.50. 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 $140. The maximum gain is $260 per contract. That is a potential gain of about 85% based on the amount risked in the trade.
Now, let’s look at the details.
United has been forming a base after an extreme decline in the bear market that began in February.
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Despite the continuous stream of bad news related to the travel industry, the stock has remained well above its March lows. This is a potentially bullish sign for the stock.
The risks of the airlines have been a factor many investors consider when weighing trades in the sector. Risks of another down move in the sector are high, but they can be managed.
First, let’s consider a potential catalyst for a price move. A return to normal service could help the stock and UAL took a step in that direction. According to PR Newswire,
“United Airlines [recently] announced it will increase service to China from two to four weekly flights between San Francisco and Shanghai’s Pudong International Airport via Seoul’s Incheon International Airport.
Beginning Sept.4, 2020, United will operate four weekly flights with Boeing 777-300ER aircraft from San Francisco to Shanghai on Wednesdays, Fridays, Saturdays and Sundays.
Customers traveling from Shanghai will return to San Francisco on Mondays, Thursdays, Saturdays and Sundays. Tickets will be available for purchase beginning Wednesday, Aug.19 on united.com and the United mobile app.
“United has served mainland China for more than three decades and we look forward to continuing to connect customers traveling between the U.S. and Shanghai with two additional flights beginning in September,” said Patrick Quayle, United’s vice president of International Network and Alliances.
In July, United began operating twice-weekly service between San Francisco and Shanghai via Seoul. United was the largest U.S. carrier serving China prior to suspending service in February due to COVID-19. In 2019, United operated five daily flights between Shanghai and its hubs in San Francisco, Los Angeles, Chicago and New York/Newark.
United is committed to putting health and safety at the forefront of every customer’s journey, with the goal of delivering an industry-leading standard of cleanliness through its United CleanPlus program.
United has teamed up with Clorox and Cleveland Clinic to redefine cleaning and health safety procedures from check-in to landing and has implemented more than a dozen new policies, protocols and innovations designed with the safety of customers and employees in mind.”
This could prompt a return of a significant number of passengers.
The weekly chart highlights a potential upside in the stock if the company could achieve its prior level of revenue and earnings.
There is risk in the sector and a spread trade could reduce risks.
A Specific Trade for UAL
For UAL, the September 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 September $36 call option can be bought for about $2.90 and the September $40 call could be sold for about $1.50. 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 UAL, the maximum gain is $260 ($40- $36= $4; 4- $1.40 = $2.60). This represents $260 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 85% 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 UAL 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.