There was a time when the transports were the hot sector to watch on Wall Street. They served as a great barometer to the whole market. But they have long lost their leadership role except for sporadic stints. Airliner Southwest Airlines (NYSE:LUV) stock tracks the iShares Transportation Average ETF (BATS:IYT) very tightly. And it now sits in the middle of the six-month range.
This is important to note because LUV is going to deliver earnings next week. This week United Airlines (NASDAQ:UAL) stock rallied off its earnings report, so there is definitely an opportunity for LUV stock price to do the same next week.
But I am most interested in the support below, and this will become clear at the end.
The short-term reactions to earnings are always binary, so this adds a bit of gambling flair to the trade. Even if management gives us the results ahead of time, we cannot guess how investors will react to them.
Handling UAL Stock Into Earnings
It’s all about managing expectations and we all know how things can go bad like what happened to Netflix (NASDAQ:NFLX) yesterday. The estimates create uncertainty, because if management misses them, investors sell the news even if the results are actually good in absolute terms.
But it is important to note that this binary effect is temporary. The fundamentals and the technicals will retake the reins of the Southwest stock price once the event headlines abate.
Last year, the transports fell 25% into Christmas but has recovered well since then. Like LUV, the IYT also now sits in the middle of the six month range.
So what does this mean for LUV stock price at these levels? The bulls are in control and will continue to buy the dips. After all we now know that the Fed cast its safety net back out.
So, if I’m long the stock already, then I have no reason to leave it because the fundamentals that got me into LUV have not changed. Airlines have developed a new way of doing business in the U.S. that has almost erased the old stigma of shoddy operations.
I am flying today and I can assure you that I paid for many extra fees that didn’t exist just a couple years ago. Critics point out that they lack overall pricing power but they are making up for it with additional fees from every angle.
This is all to say that the Southwest team is executing on plans well enough to warrant the current valuation.
Technically speaking, LUV stock has been setting higher lows while knocking at the $54 per share neckline. It has also bounced off of $48-per-share support zone four times, with the exception of a deeper dip into the Christmas market-wide debacle.
So the bulls have the benefit of solid support below while attacking a resistance level. Often times the bears get tired of defending the resistance and the bulls overshoot higher. In this case, the outside target would be $58 per share with resistance at $56.
Some investors prefer to hold stocks for the very long term. And for those, the $58 resistance won’t matter. For the faster traders, $58 is a target area to exit the trade, or at least book some profit.
However, if the bulls are able to break through that resistance then it becomes the next upside opportunity to extend the rally and set new all-time highs. There would obviously be resistance at $64 in that scenario.
The Bottom Line on Southwest Stock
While owning shares of LUV is a legitimate trade opportunity, I prefer to use options in my trading. So in this case, since we noted that that there is solid support below, I prefer selling downside puts into what others fear. This way I can create income without any money out of pocket.
For example, I can sell the Dec $45 put and collect $1 for it. All I need to profit is for the LUV stock price to stay above that level. Otherwise I own the shares at $45 and break even at $44 per share.
Compare this with owning shares now and risking my money with no margin for error. By selling the puts I create a 13% moat around my risk. And I don’t even need a rally to win.
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. Join his live chat room free here.
