Airline bulls look for brighter spring
03/15/17

Airlines got hammered by yesterday’s blizzard, but traders are looking for a brighter spring.

A blanket of snow grounded over 5,000 flights on Tuesday. That added to the troubles of an industry hit by weak pricing, profit warnings, and concerns about foreign-travel restrictions. All told, the Amex Airline Index has begun 2017 with a 5 percent drop, badly lagging the broader S&P 500’s 6 percent gain over the same period.

But the sector has outperformed over the last five years, and some traders are looking for sentiment to improve along with the weather over the next three months. 

Delta Air Lines (NYSE: DAL) topped the activity, with 40,000 June 50 calls purchased for $1.37 and a matching number of June 55 calls sold for $0.38. That translated into a net cost of $0.99.

Calls are options to buy a security at a specific price. Owning them lets investors make money to the upside, while selling them creates an obligation to deliver shares should a certain level be reached. Yesterday’s transaction will essentially go long DAL if it climbs to $50 and exit at $55 if that price is reached on expiration. The potential $5 collected in the process would represent profit of more than 400 percent based on their $0.99 outlay. 

Known as a vertical spread, the strategy is designed to leverage a move of limited size. It will result in a total loss of principal if no rally occurs. 

American Airlines (NYSE: AAL) had a slightly more complicated trade but which suggests similar hopes for a rebound. This time, 10,000 May 45 calls were bought for $1.10 and matching blocks of the May 48s and 50s were sold for $0.49 and $0.27, respectively.

XAL vs SPX

Source: E*TRADE Pro

The AAL strategy, sometimes known as a “Christmas Tree” cost $0.34 and will return 782 percent from a $48 close on expiration. It also left the investor effectively short 1 million shares at $50 (with potentially painful losses above that level), so they’re probably using the options in conjunction with a position in the underlying stock. 

DAL slid 1.30 percent to $46.28 yesterday, and AAL closed down 2.74 percent to $41.21. Both stocks hit their lowest levels since November. 

Despite the sector’s recent weakness, investors may be heartened by consistently strong economic data (generally a positive for transportation stocks). Oil prices have also fallen sharply in the last week, which may be viewed as helping ease fuel costs.

In summary, airlines are long-term outperformers in the midst of a pullback, and some big investors are using options to wager on a rebound next quarter.