Shares of American Airlines (NASDAQ:AAL) have fallen sharply after reporting better-than-expected earnings on July 26. AAL stock is now nearing the lowest levels in nearly a year and fast approaching major support at the $35 area. Given the solid fundamentals and improving technical backdrop, I think the recent weakness if AAL is nearing a climax. Look for AAL stock to begin to take off in the very near future.
American reported earnings of $1.63 per share, beating consensus estimates of $1.59 per share. This marks the fourth straight quarter that the company has exceeded EPS expectations, yet AAL stock has actually fallen almost 25% in that time frame. This combination of lower stock price and higher earnings makes for a comparatively lower P/E ratio and a more attractive valuation for American Airlines, which now stands at less than 10 on a forward basis.
From a technical viewpoint, AAL stock is approaching major support at the $35 level, which has been a springboard for a rally in the past. As one of the largest U.S airlines, American is normally highly correlated to fellow competitors such as United (NYSE: UAL). A look at the chart shows that correlation remaining strong up until mid-April. Since that time, however, AAL stock has been a dramatic under performer to UAL stock, with United rising sharply and American dropping. I look for the spread between the two to converge back towards the mean, with AAL stock being a relative out performer over the coming weeks.
Implied volatility (IV) in AAL options has fallen recently and is now at just the 27th percentile. This means option prices are comparatively cheap, especially when compared to historic volatility in the 45th percentile. This favors long option strategies when constructing trades.
So to position for lift off in AAL stock, a call calendar spread makes probabilistic sense.
Trade Idea for AAL Stock
Buy AAL Nov $40 calls and sell AAL Sep $40 calls for a 75 cents net debit
Maximum risk on the trade is $75 per spread. Ideally AAL closes near the $40 level at September expiration to realize the maximum potential gain. The trade structure also allows additional selling of October call options if the September calls expire worthless.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility.