Amid volatility in the airline sector, one trader stays on board

Airlines took a beating yesterday, but one big trader is staying on board a major carrier.

Delta Air Lines (NYSE: DAL) warned last Thursday, March 2, that it won’t raise fares as much as some investors had hoped. Further downside came Monday morning when higher fuel costs prompted the company to cut its margin guidance for the current quarter. 

While DAL has been the company with the news, options activity focused on rival American Airlines (NYSE: AAL). In the single biggest transaction of the day, an investor purchased 10,000 31-March 45.50 calls (options to buy a security) for $1.31. They also sold 10,214 of the 31-March 48.50 calls for $0.37, resulting in a net cost of $0.94.

The strategy appears to be a vertical spread, which uses income from the higher-strike contracts to reduce the cost of the calls closer to the money. That creates the potential for greater leverage on a percentage basis. In this case the $0.94 outlay will more than triple to $3 if AAL climbs 9 percent to $48.50 by the end of the month. Without a rally, the position will expire worthless.

It’s also possible that he or she previously owned the 48.50s in hope of a breakout but saw them lose value as the stock declined. In that case, they paid additional premium to swap into the 45.50s. Either way, they’re looking for a move higher in coming weeks. AAL ended yesterday’s session down 3.23 percent to $45.31, fighting back from a midday decline of over 5 percent.

Airlines (as measured by the AMEX Airline Index) delivered more than quadruple the gains of the broader S&P 500 in the second half of 2016, partially driven by news that billionaire Warren Buffett was building positions in top names. They began this year on a positive note as investors looked for the strong economy to lift fares, but hit turbulence in late January amid travel restrictions and labor-cost worries. The AMEX Airline Index is now down 1.7 percent on the year, well behind the S&P 500’s 6 percent gain. 

American Airlines maintained its guidance in its last monthly traffic report and its next set of numbers is due this week. So, Monday’s call buyer may be looking past those broader concerns and looking for sentiment to rebound in the company.

Overall options volume yesterday was more than six times the monthly average in AAL, with calls outpacing puts by 4 to 1. 

In summary, one big investor is looking for AAL to resume its longer-term rally after a weak start to 2017.