Articles

By: Costas Bocelli — March 13, 2019

Tempted to “Double Down” on Boeing? Do This Instead…

The Boeing Company (BA) is considered the ultimate non-cyclical cyclical stock.

Costas

Between Boeing and Airbus Group (AIR.Euronext Paris), the two companies maintain a virtual duopoly on the global commercial jet aviation industry.

Boeing is coming off of a banner year.

The company posted full-year 2018 revenue of $101.1 billion and GAAP earnings per share of $17.95, both record annual results.

And the outlook for 2019 seems even more promising.

Boeing expects revenue of between $109.5 billion and $111.5 billion, and GAAP EPS of between $21.90 and $22.10.  This of course is possible because their book of business extends beyond the horizon.

At the end of the fourth quarter, the total company backlog was relatively unchanged at $490 billion and included net orders for the quarter of $27 billion.

Boeing’s future prospects are literally CAVU -- ceiling and visibility unlimited.

And so has been the performance of the stock.

Since the early-2016 correction lows, BA has been the best-performing stock in the Dow Jones Industrial Average, having gained more than 300%.

(Click any image to enlarge)

BA 3 yr

In terms of technical strength, BA has all the qualities we look for in a good investment:

  • Long-term positive trend on its price chart...
  • Positive relative strength versus the stock market...
  • Positive relative strength versus its sector peers (Aerospace Airlines).

But just because everything is seemingly firing on all cylinders, that doesn’t mean the company and the stock are impervious to bad news.

Over the weekend, a four-month-old Boeing 737 MAX 8 airliner crashed just outside of Ababa, Ethiopia barely six minutes after takeoff, killing all 157 passengers and crew.

This is the second fatal crash in five-months involving this particular Boeing-manufactured aircraft.

The exact cause of the recent crash is still being investigated. And whether it can be linked to the cause of the crash five-months-ago in Indonesia, aviation regulators around the globe are taking no chances and are grounding Boeing’s 737 MAX 8 aircraft.

However, Department of Transportation regulators in the United States, where Boeing is based, said it would not ground the planes, adding that a review “shows no systemic performance issues and provides no basis to order grounding the aircraft”.

But they did go on to say, “It will take immediate and appropriate action if issues are identified”.

U.S.-based airlines that operate the Boeing 737 MAX 8 include Southwest Airlines (LUV), American Airlines (AAL) and United Continental Airlines (UAL).

While the Federal Aviation Administration may be giving Boeing (and the 737 MAX 8) the benefit of the doubt as the investigation continues, investors have been taking a “Sell first, ask questions later” approach.

It’s been a bad week thus far for Boeing’s stock.

BA posted its biggest two-day drop in a decade, declining more than 11% on Monday and Tuesday.

With the stock recently trading around $375 per share (Wednesday morning), BA is down roughly 15% from its all-time record close just two-weeks ago, on March 1st.

BA SRS

As you can see from the accompanying price chart, the stock has now pulled back and filled the gap (yellow highlight) after the positive reaction that followed when the company reported earnings on the January 29th.

And just below this level, you’ll find the 200-day moving average (blue line). For bullish investors, these areas can be construed as an area of support and could present a buying opportunity.

But here’s the thing… The current situation is very fluid. Where this investigation goes in the short-term, so goes the stock.

For sure there is the potential for further downside risk…

About That Backlog

While we pointed to the fact that Boeing has a massive book of business, a significant portion of it includes 4,600 orders for the 737 MAX, which accounts for 33% of Boeing’s total revenue for the next five years, according to the Goldman Sachs analysts who cover the company.

Yikes! This makes buying and accumulating stock a risky proposition.

The good news is that we can incorporate options to make investing less risky, not more. In other words, if you’re inclined to take a bullish position, you could purchase Call options or Call spreads which carry a limited amount of risk.

And if you think the issue with the planes is going to have a severe impact on the company, you can also use options to take a bearish position -- purchasing Put options or Put spreads which also carry a limited amount of risk.

What about investors who own the stock and are thinking about buying more? It might be the opportunity you’ve been looking for -- a chance to buy more shares on weakness, even if you have to take some bad news along with your added shares.

But for me, and I’m guessing you as well, adding more exposure in the face of so much uncertainty would feel too risky.

So... Is there another way to add bullish upside exposure -- right here, right now -- without taking on any more risk?

Yes! There is a powerful technique for accomplishing exactly that.  Once you learn this strategy, you'll be able to apply it to most listed securities, not just BA.

This repair strategy harnesses everything that’s great about options, and takes advantage of their benefits.

It’s called a Ratio Vertical Spread.

Don’t let the complicated name fool you.  The strategy is quite simple and easy to learn.  It's particularly useful when a long stock position has sold off, like BA has, but you still feel good about holding onto it in hopes of a rebound.

It’s designed to give your stock position added upside potential, like a jet engine.  Best of all, the technique carries minimal risk and, if structured properly, it can be put on for free or at a very minimal cost (in some cases, you can get paid for extra upside potential).

The best part:  It does not add any additional downside risk other than what you already have on your existing stock position!

When used as a repair strategy for a long stock position, the ratio vertical spread  simply entails buying ONE slightly out-of-the-money Call and selling TWO higher strike out-of-the-money Calls against it.

You’ll want to do this in the same expiration date (preferably 3-6 months out) while maintaining the proper ratio.  The proper ratio is: For every 100 shares of long stock you wish to repair, you'll buy one Call option at the lower strike, and sell two Call options at the higher strike.

That essentially leaves you with a bull call vertical spread, plus an added higher-strike call contract which you've sold.  Even though you’re short that extra call contract, you’re still completely covered by the long stock position.  You’re truly hedged.

In the case of BA, for every 100 shares of stock held, you could look to buy one June 385 Call and sell two June 410 Calls to create the ratio vertical spread.  With the stock recently trading around $375, the trade can be purchased at no additional cost, to gain the leverage.

In fact, you get to collect a $150 credit!

What this essentially does is give you additional upside potential (although limited) without having to pay for it, because you finance the vertical spread cost by selling that extra Call contract.  At the current prices, it sets up as credit, so you get paid.

The idea is that if the stock does indeed recover and trade higher, the option structure will act like a double stock position in between the two option strikes, magnifying your gains.

If this result materializes, you’ll find that your repair strategy has made up a great deal of your previous losses, with a smaller move in the underlying stock price.

Ideally, you’ll want the stock to trade above the short call strike, which is your maximum profit gain and likely your position exit.  At that point, not only have you picked up all the gains from the long stock position, but you’ll pick up the difference between the two option strikes for an additional gain.

If the stock does not rally back up... well, then you’re essentially in the same position as when you put on the trade.  But you'll have incurred no additional losses from the option trade, because you’ll have laid out nothing to buy the 1x2 ratio spread.

You will face an opportunity cost.  Should the stock really take off and soar even higher, beyond the higher strike where you sold the Calls, your gains will be capped at that point and your stock position will be called away.

But hey, remember: This is a repair strategy.  You use it when you've already been stung pretty good.  So, my feeling is at the by the time you feel the need to put this technique to use, you'll be more than happy with the result.

Want to learn more about options and how they can make you a better investor?  Then you’ll want to check out Options Soup, our options education program.

Chris Rowe and I designed Options Soup to teach the greenest investor everything she needs to know about options in an easy to understand format.

Give us a call at 855-822-0269 and ask to save a seat.

Until next time!

Costas

Costas

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