The long road to recovery in airline stocks has begun. Investors have looked far off into the future and like what they see for the industry. At least, they like it more than they did before November. So says the share prices of all the major carriers like United Airlines (NYSE:UAL), whose share price has grown over 40% in the past month. Today we’re going to build the bull case for United Airlines stock and show how you can tap into the leverage of options contracts to ramp up your returns.
UAL and crew’s sentiment shift is a byproduct of multiple positive developments seen over the past six weeks. Despite fears of turmoil and uncertainty, the presidential election has come and gone with little adverse impact on equity prices.
Not soon thereafter, a whole host of drug companies released overwhelmingly positive data about their forthcoming vaccines. It was just the catalyst needed to spark a mass migration back into economically sensitive areas.
Airlines, casinos, restaurants, financials, energy, and yes, airlines all screamed higher, sending shorts running for cover. Simultaneously, spectators waiting for signs that the coast was clear finally rushed in.
Lagging small-caps have now donned a leadership role, and that’s good for United Airlines stock. Not that’s it’s needed, but a seasonal tailwind is also blowing for asset prices. November and December have historically been a friend to stocks. Absent some exogenous surprise shock to the system; I can see equities drifting higher into year-end.
United Airlines Stock
You don’t have to join airline buyers based on the seductive narrative above alone, however. The price action in UAL alone provides compelling reasons for banking on higher prices. The weekly trend is starting to turn higher, but it’s the daily view that tells the tale. Entering November, United was a dead-money stock, drifting aimlessly. Exiting the month, it’s a red-hot ticker hounded by momentum traders. It’s a stark contrast, to be sure, and makes me a believer in the recovery.
The 20- and 50-day moving averages are cruising higher, and we’ve carved out a clear series of higher pivot highs and lows. We’ve seen some much-deserved consolidation over the past three days. The pause is allowing the 20-day moving average to catch up and overbought pressures to ease. While a few more days of backing-and-filling would be welcome, it’s already a good enough setup to build trades around.
Let’s look at how we can use options to supercharge our returns.
Call Spreads are Appealing
If you’re interested in increasing the odds of success while leveraging returns, then creating a call spread is worth consideration. Implied volatility is somewhat low at the 17th percentile making long call diagonals attractive. I prefer them over a vertical spread because of the higher rate of time decay. We will profit even if the stock treads water or falls slightly.
The position consists of buying a longer-term in-the-money call while selling a short-term out-of-the-money call against it. Here’s the structure I like:
Bull Call Diagonal: Buy the Mar $45 call while selling the Jan $55 call for a net debit around $6.60.
You should capture a profit as long as the stock sits above $48 at expiration. If it rises toward $55 near expiration, you can grab $400 to $500 in profits. Compared to the original trade cost of $660, that translates to a potential 60% to 75% return.
All we need then is about an 11% rise in the price ($49.30 to $55) to generate a 60% to 75% gain. That’s, dear readers, is leverage.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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