Shares of American Airlines (NYSE:AAL) are finally finding some footing after a brutal sell off. AAL stock had plunged to the lowest levels ever as coronavirus fears rocked the airline industry. While travel has been undoubtedly affected in the short term, the longer term outlook is certainly not as dire. Volatility and crisis beget opportunity in investing. Longer term investors should look to add a hedged position in AAL stock to their portfolio at current levels.
The coronavirus’ effect on airlines has taken a serious toll. Travel restrictions combined with dramatically lower demand from both business and holiday travelers alike has brought demand down to levels rarely seen.
In response, Washington has vowed to help the airlines in any way possible through this rough patch. It will undoubtedly take some time for travelers to feel comfortable flying again. Once they do, however, the pick up in flight booking should return near normal levels. One only needs to look at 9/11 to see a similar scenario.
The short-term outlook is clouded at best. Longer term investors, however, can look at historically cheap valuations and oversold technicals to take advantage of the fear. As Warren Buffett famously said, “Be greedy when others are fearful.”
Valuation View
AAL stock is now trading at a P/E ratio of 4.2, by far the lowest multiple in the past five years. Other metrics, such as a P/S ratio which is under one, are at similar trough valuations. The last time American Airlines was even close to this cheap was June 2016, which marked a major bottom in AAL stock.
Fuel costs account for roughly one third of the overall cost structure for airlines. Oil prices saw their biggest drop since 1991 on Monday as OPEC fell apart. Jet fuel prices fell over 35% since the beginning of the year. This massive cost saving should help American Airlines as it navigates thru the coronavirus downturn. The combination of historically low valuations and historically low fuel costs will definitely temper the effects of historically low seat bookings.
Technical Take
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American Airlines stock is looking decidedly better from a technical perspective. 9-day RSI breached the 20 level before turning higher. Bollinger Percent B went negative but is now back in positive territory. MACD was at by far the most oversold readings of the past year before strengthening.
AAL stock is trading at a massive discount to the 50-day moving average of $25.94. Previous times when American Airlines approached these oversold levels marked a significant low in AAL stock.
Current implied volatility (IV) for AAL options is at 100%. This means option prices are at the highest levels in the past year. The combination of cheap stock and expensive options sets up ideally for a covered call trade, buying AAL stock and selling AAL call options to hedge.
AAL Stock Trade Idea
Buy AAL stock and sell January 2021 $18 call for a $12 net debit
Selling the call option reduces the net cost of buying AAL stock by the premium received of $5. This equates to a nearly 30% downside hedge for the stock. Ideally AAL stock closes above $18 at Jan. 15, 2021 expiration. The shares would then be called away at $18 for a 50% return.
If American Airlines is under $18 at expiration then investors can look to re-hedge by selling additional call options to further lower the cost basis.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com.
