Cruise stocks hit an iceberg on Monday. The sudden sinking pulled Royal Caribbean (NYSE:RCL) down 7% on heavy volume. With the drop, RCL stock is now testing a crucial support zone. How it responds will be an important signal for traders.
Situations like this provide opportunities for bulls and bears. I’ll make a case for both, and then share my favorite strategies for capitalizing.
Let’s first look at the broad market themes that drove Monday’s fallout.
Monday’s down open weighed on virtually every sector. At least initially. The S&P 500, Nasdaq and Russell 2000 all began deep in the red, but that’s where the similarities end. Once the opening bell rang, buyers swarmed both large-caps and the technology sector. At the same time, small-caps continued to sink like a stone. By day’s end, the Russell 2000 closed down 3.5%. By comparison, the tech-heavy Nasdaq finished slightly in the green. That’s a huge discrepancy and shows just how much the little guys suffered.
The biggest losers included casinos, restaurants, cruise lines and airlines. Notice a theme? They’re all companies that have traded together in the wake of the novel coronavirus. Many of their shares were well on their way to recovery — until this week’s rug-pull, that is.
Now election jitters and fears of a resurgence in Covid-19 during the fall are front and center. Once upon a time, the market was ignoring such threats. But no longer. This week’s decline below the 50-day moving average officially puts bulls on the defensive.
The Bear Case for RCL Stock
Ever since the first quarter fiasco that plunged Royal Caribbean shares into the abyss, the 200-day moving average has been barreling down on the stock. And this month, the long-term smoothing mechanism finally caught up with prices. For two weeks, RCL wrestled with the 200-day moving average. The price even pushed above it during a few trading sessions before falling back by the closing bell.
The failure to power above resistance reaffirms the dominance of the long-term downtrend. With Friday’s slide, RCL stock is also now back below the 20-day moving average as well. The beautiful thing about the 200-day holding firm as resistance is it provides an easy line in the sand for our bearish thesis. As long as we remain below it, bear trades have a green light. Break above it, however, and I’d switch sides.
With options, we can build a trade that bets on Royal Caribbean shares remaining below $70 for the next three weeks.
Bear Trade: Sell the Oct $70/$75 bear call spread for 95 cents.
If the stock sits south of $70 at expiration, then you’ll capture the max reward of $95 per contract. The max risk is $405, but if you exit when the stock rises above $70, then you’ll reduce the loss to around $100.
The Bull Case
Given the analysis thus far, you may be thinking the bull case has already been shot to shreds, but it hasn’t! As nasty as Monday’s movement was, I can still see a path to profits for buyers if a few things line up. For starters, we are holding the rising 50-day moving average. The ascending trendline that has defined RCL stock’s recovery efforts since March also remains intact.
The fact that we’re testing both levels right now illustrates how compelling the current entry is. If support holds, and we return to the 200-day near $70, there’s about $8 of upside. And if we exit on a breach of the floor near $59, there’s only about $3 of downside.
That’s a compelling enough reward-to-risk ratio to justify taking a trade. While you could always spice it up a bit with options, I’m sticking with a straight stock play.
Bull Trade: Buy RCL above $62.30, with a stop below $59. Target $70.
On the date of publication, Tyler Craig did not hold, directly or indirectly, positions in any of the securities mentioned in this article.
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