After struggling through a tough January, shares of American Airlines Group Inc (AAL) finally broke out of the downtrend and look poised to head higher.
Click to Enlarge AAL stock made a new recent low on Feb. 8 at $34.76, but rebounded sharply. AAL rose back above the $37.50 support area and also broke the downtrend at $38.53. This upside breakout of a wedge pattern is bullish, and I expect AAL stock to continue higher over the next few months from a technical perspective.
Fundamentally, American Airlines trades at a big discount on a valuation basis to its peers. AAL stock carries only a 3.7 price-to-earnings ratio compared to an 8.6 P/E for Delta Air Lines, Inc. (DAL) and a 12.8 P/E for Southwest Airlines Co (LUV).
While some of this discount is attributable to a greater debt load for AAL, the company still has $6.9 billion in cash and short-term investments on the balance sheet following record earnings.
Click to Enlarge I look for this valuation gap to narrow, with American stock being a relative outperformer to its peers.
The options market is positioning for some upside in American Airlines stock, with large repeated call buying. Of particular note were the 16,711 March $42 calls that traded on Feb. 19, versus only 1,413 open interest. Since that time, there has been additional buying across several strikes in March, as a large player builds a position.
The AAL Stock Trade
Click to Enlarge This type of big, repeated buying many times is a precursor to further upside in the stock. I want to follow along with this big call buyer, but defray some of my cost and risk, by going long a call spread.
Specifically, I would look to go long the AAL April $42 calls and short the AAL April $45 calls for a $1.10 net debit. These are the regular monthly options that expire on April 15. The short $45 strike is positioned just below the major technical resistance level of $47.
The maximum risk on the trade is $110 per spread, with a maximum gain of $190 per spread. The maximum loss is realized if AAL stock closes below $42 on April expiration, while the maximum gain is achieved if AAL stock is above $45 on April expiration.
I would look to revisit the position after March’s monthly expiration and make any necessary adjustments, either taking partial profits or trimming out some losses.
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 tbiggam@deltaderivatives.com.
