Considering a Long Call Position in Air Canada

The COVID crisis has been especially hard on airline stocks. The stock price of Canada’s largest airline, Air Canada, collapsed from over $50 in January to $10 in March.  Although the stock has recovered somewhat since then, when compared to other equities the bounce has been anemic.

Chart 1: Air Canada (symbol AC) over past year

Source: Bloomberg

To get flying again, it is essential for Canadians to feel safe, and some of the more pessimistic forecasts assume that airlines will not return to normal until we have a vaccine.

However, recently there have been improvements in the technology used for rapid COVID-19 testing, and this has opened up new possibilities.  From the Travel Off Path website:

• A new pilot project for Canada has been launched at the Calgary International Airport that will drop the mandatory quarantine in lieu of Rapid COVID-19 testing. 
• The federal government of Canada, along with the provincial government in Alberta, have jointly announced that a new pilot program launched in Alberta will see the mandatory 14-day quarantine greatly reduced to around 48 hours for travelers returning home. 
• The pilot project will launch on November 2, 2020 at the Calgary International Airport. 

If this pilot program is successful, it could result in a dramatic increase in Canadian airline travel.

There are still risks, so it is understandable if an investor does not feel comfortable buying stock in Air Canada until the program is officially adopted. 

However, there is an alternative strategy which will allow the investor to participate in an improvement in Air Canada’s stock price, while limiting the risk.

The investor can purchase call options on Air Canada.

According to the Montréal Exchange Strategy guide, a long call strategy can be described as follows:

• A long call strategy typically doesn’t appreciate in a 1-to-1 ratio with the stock, but pricing models often give us a reasonable estimate about how a $1 stock price change might affect the call’s value, assuming other factors remain the same. What’s more, the percentage gains relative to the premium can be significant if the forecast is on target.
• The call buyer who plans to resell the option at a profit is looking for suitable opportunities to close the position out early: usually a rally and/or a sharp increase in volatility. Some investors set price targets or re-evaluation dates; others ‘play it by ear.’ Either way, timing is everything for this strategy, because all value must be realized before the option expires. Being right about an anticipated rally does no good if it occurs after expiration.

Chart 2: Long Call Strategy Diagram

Source: Montréal Exchange

The December 18, 2020 call with a strike of $17.00 can be purchased for $1.75 (price on October 22, 2020).  By purchasing this call option, the investor will have the right, but not the obligation, to purchase Air Canada stock at $17.00/share at any time up until expiry in December. 

If the pilot program is unsuccessful, and Air Canada stock falls back to a low of $10.00/share, the investor will only lose the initial outlay of $1.75 for the cost of the option.

However, if the program is successful and Air Canada’s price appreciates towards its $24.00 June high (before the December expiration), then the profit could be:

In a situation such as this, where there is considerable risk in the underlying asset price, purchasing a call instead of owning the stock can be an attractive alternative that defines the worst-case risk scenario yet captures the upside potential if market sentiment toward the stock starts to shift.

Disclaimer:

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.