This article was written in English on 03.03.2021, translated and published on this site.
We previously looked at how investors can evaluate creating hedged call options for equity assets. Our readers who are new to options may want to take a look at our previous post before continuing with this post.
Today we’ll look at how a hedged call option can help protect the latest gains at Carnival should the market rally stall in the coming weeks.
- Day-to-Day Price: $ 26.62
- 52-Week Range: $ 7.80 – $ 33.34
- 1 Year Price Change: approx -21%
In March 2020, Carnival was proud to be the world’s largest cruise ship operator. Group P&O Cruises, Princess, Cunard, Costa and Holland America own several major brands. However, in March 2021, the post-coronavirus world looks a little different for Carnival and other names.
Management currently cannot predict when the entire fleet will be able to return to normal operations and, as a result, cannot provide a profit forecast. However, the company expects a net loss on both a US GAAP basis and an adjusted basis for the first quarter and for the full year to be completed on 30 November 2021. The company’s average monthly cash spending rate in the fourth quarter was $ 500 million. The company expects this rate to be around 600 million dollars in the first quarter of 2021.
With the recent rise in the CCL share price, a hedged call option may be a suitable strategy for investors who believe the stock is unlikely to rise further in the coming weeks.
Covered Call Options for CCL Shares
The strategy requires the trader to sell one hedged call option with a future deadline for every 100 shares owned.
On Tuesday, CCL stock was trading at $ 26.62, but closed slightly above that level. However, for this review, we will use the price seen at the time of writing.
A share option contract for CCL (or any other share) is an option to buy (or sell) 100 shares.
Investors who believe that short-term profit sales may soon be possible may use a small amount of intrinsic value, or a hedged call option at profit (in-the-money). A protected call option is profitable if its market price (here $ 26.62) is above its strike price.
This means that the investor buys (or already owns) 100 CCL shares at $ 26.62 and also sells a hedged call option with a strike price of $ 25, dated April 16, 2021. This option is currently available at a price of $ 3.85 (or a premium).
An option buyer pays a premium of 3.85 X 100 = $ 385 to the seller of the option. Transactions for this call option will end on Friday, April 16, 2021.
The strike price of $ 25 offers more downside protection than either at-the-money or out-of-the-money options.
Assuming a trader enters this hedged call option trade at $ 26.62, the maximum earnings on the deadline would be $ 223 ((3.85 – (26.62 – 25.00)) X 100, excluding commissions and charges)
Risk / Profit Profile of Covered Call Option
The maximum profit of an intrinsically valued hedged call option is equal to the exogenous value of the option.
Intrinsic value means the variable value the option would have had if it was used now. Therefore, the intrinsic value of our CCL call option is (26.62 – 25.00) X 100 = $ 162.
Exogenous value is the difference between the market price of an option and its intrinsic value. In this example the exogenous value would be (385 – 162) = 223 dollars. Extrinsic value is also known as time value.
The trader receives this $ 223 profit as long as the price of the CCL share at the last date is higher than the exercise price of the call option (ie $ 25.00).
At the deadline, this transaction will break even at a point where the CCL share is $ 22.77 (25.00 – 2.23) excluding commissions and charges.
Another way to consider the break-even price is to subtract the call option premium ($ 3.85) from the price of the CCL share ($ 26.62) at the time we created the call option.
On April 16, if the CCL stock closes below $ 22.77, the trade starts losing money during this hedged call option setup. Therefore, by selling the call option, the investor protects against a potential fall in stocks. The price of a share could theoretically go down to zero.
What if Carnival Stock Reaches a New Historic Peak?
As we have stated in our previous articles, such a protected call option limits the upside profit potential. The risk of not fully participating in the potential rise that CCL stock will experience may not attract everyone. However, others may find this acceptable in exchange for the premium they will earn, based on their risk / benefit profile.
For example, if CCL stock reaches a new high for 2021 and closes April 16 at $ 35, the trader’s maximum earnings would still be $ 223. In such a case, the option would have a high intrinsic value and possibly be used. Some brokerage fees may also be applied in case the share is called up.
As part of the exit strategy, the trader can also shift this high intrinsic call option. In this case, the trader buys back the $ 25 option before the April 16 deadline. Based on the views and goals for the CCL stock, the trader may consider creating a new hedged call option. In other words, the trader could potentially create a call option with the expiry May 21 at a favorable strike price.
Predicting exactly when CCL stocks will take a break is a daunting task, even for professional traders. However, option strategies can offer tools to prepare you for horizontal movements or even declines in stock prices.
Note: If you are interested in the financial products mentioned above but cannot find these products in your area, you may want to contact your brokerage firm or financial planner.
You can contact me for any questions or comments.
Editor’s Note: Not all assets analyzed may not be available in all regional markets. Please contact an authorized brokerage firm or financial advisor to find similar financial instruments that may suit you. This content is for informational purposes only. Before making any investment decision, you should do your own detailed research.