Today Southwest Airlines Co (NYSE:LUV) is down nearly 4% on the earnings reaction. We rarely see LUV down this big in one candle, so I want to simply capitalize on this opportunity. Don’t confuse today’s trade with my expectations of an impending rally. The way I am setting this up only requires me to choose a level low enough that it won’t be tested.
Fundamentally, Southwest is not expensive versus its peers, which is important since it’s seen as a premier operator. Most reviews I read are complimentary of the way the company operates as a business and by how it treats its passengers.
Most users of Southwest Airlines actually love flying them. So LUV stock being a successful business does not come at the expense of the user experience.
Technically I do have to worry about losing the ascending higher low trend. Often if such trends are lost, they invite more technical sellers. Furthermore, LUV has already rallied over 50% since August, which adds to this technical vulnerability.
Lastly I also have to worry about the fact that after this dip, there might be chatter of double tops.
Click to Enlarge I bet that in the long term, these technical worries are balanced by decent valuations and humble analyst expectations. So I am willing to start a long position, but one that has room for error. So instead of buying the stock outright and risk my money right here, I will use options where I can build a buffer.
LUV Stock Trade Idea
The Bullish Bet: Sell the LUV Sep $45 naked put and collect per 90 cents per contract. This trade has a 90% theoretical chance of success with a 17% buffer from the current price even after this dip. But if LUV falls below my strike I would suffer losses below $44.10 per share.
Not all traders are comfortable selling naked puts, as it could be dangerous. For those people, I can modify the trade into a sold credit put spread to mitigate the risk size.
The Alternate: Sell the LUV Sep $45/$44 which is also a bullish bet. Both trades have about the same chances of success but here my maximum risk is limited to the width of the spread and what I collect to open. The reward if successful is an impressive 15% on money risked. Compare that with having to risk $54 now and hope that LUV rallies 15% from here.
Learn options as easy as 1-2-3 in a personal 1on1 webinar here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
