After recommending several bullish trades in a row, I am recommending a bearish ratio put debit spread on Hilton Worldwide Holdings Inc. (NYSE:HLT), the hotel owner and operator.
This trade is a cheap way to add some bearish protection to your portfolio while we are waiting for the resolution to the coronavirus — COVID-19 as it is now known — outbreak.
At this point, talking about the virus must seem old, but as the World Health Organization warned yesterday, this outbreak could still get worse.
We already saw the market open lower on Monday because of reports that this virus officially caused more deaths than SARS did. Though the market recovered throughout the day, that lower open is a reminder that nothing is settled when it comes to investors’ fears.
How Has HLT Fared?
On its fourth quarter earnings call this week, HLT’s CEO announced the company had to close 150 hotels in China because of the COVID-19 outbreak. For a company with nearly 5,000 hotels, that may not seem like many, but it will affect future earnings.
The company opened 143 hotels in the fourth quarter, adding roughly 17,000 rooms, but the closures in China, though temporary, have affected 33,000 rooms.
HLT beat both earnings and revenue estimates for the third time in a row, and it offered solid guidance. But the CEO noted that the COVID-19 situation is still evolving. We don’t know what the full impact will be.
That small bit of uncertainty is what makes this a great insurance play. HLT already acknowledged that this virus outbreak will affect its earnings for 2020. If there are any more complications because of it, investors will move their money elsewhere.
From a technical perspective, HLT looks ready to pull back. In the chart below, I have marked the stock’s up-trending resistance. As you can see, it tapped resistance yesterday. I think it will likely pull back to around $110 per share.
Daily Chart of Hilton Worldwide Holdings Inc. (HLT) — Chart Source: TradingView
The COVID-19 outbreak caused a more severe pullback in late January, and the stock has since recovered. Its 50-day moving average acted as support, so that is the level I expect it to test.
With this position, you are taking out a cheap insurance trade in case of a more severe outbreak-related pullback. However, you are also playing HLT’s technical formation. Using an upper strike price of $110 will give traders a chance to collect a profit either way.
Using a spread order, buy to open 1 HLT Feb. 21st $110 put and sell to open 2 HLT Feb. 21st $105 puts for a net debit of about $0.20.
Note: Be sure you are opening the monthly HLT options that expire on Friday, Feb. 21, 2020.
About Ratio Put Debit Spreads
A ratio debit spread is simply a way to lower the cost of buying options, as the two options that you sell to open (short) help offset the cost of the option that you buy to open. Therefore, this ratio put debit spread is a way to lower the cost of establishing a bearish put option trade. Many brokers will require the use of margin and/or a set amount of reserved capital to execute a ratio debit spread; contact your broker directly for specific requirements.
Because you are short a naked put in this ratio put debit spread, the risk is that you could be obligated to buy 100 shares of HLT at the $105 strike price for every 1 contract that you are short of the HLT Feb. 21st $105 puts. So, this is inherently a higher risk play.
InvestorPlace advisor Ken Trester also brings you Power Options Weekly, which delivers 5 new options trades and his latest trading advice to you each Friday. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.