American Airlines Group Inc (NASDAQ:AAL) reported and Wall Street did not like what it saw, so traders demolished AAL stock. Consequently, American Airlines shaved off 9% of its value in two days. Usually I let moves this big breathe a little before jumping in, but I will cautiously pounce on this one today.
Fundamentally, Wall Street still expects good things from the sector in general. AAL is cheap relative to its competition, but more importantly analyst expectations are humble with a roughly 2:1 ratio of holds versus buys. Losing $38 per share could create a technical threat to shed another $2 from there.
Click to Enlarge I am a conservative trader, so I won’t risk $43 buying AAL stock at face value. Instead I will use options where I can structure trades that allow a margin of error. The trick is to find support below where I can sell risk to generate income over time.
The Bet: Sell the AAL Nov $34 put. This is a bullish trade for which I collect $1.25 to open. By doing so I am committing to buying AAL stock at $34 if it falls below it. From here, I have an 85% theoretical chance that the trade will expire in my favor for maximum gains.
Usually I like to sell opposing risk for balance, but after a fall this big and this fast, I’d be doing it too cheaply. I could eventually add the call sale if AAL recovers in the next few weeks. Otherwise, for protection I could rent insurance by buying a few “sacrifice puts.”
The Temporary Hedge (Optional): As mentioned above, I usually refer to these as “sacrifice puts.” That is, buy the AAL June $34 put for ten cents per contract. This would give me assurances that I would be covered for the AAL stock crash scenario through mid-June. If AAL falls through my sold spread I would have no exposure and would still be profitable.
The Extra Balance (Optional): If I want to further add balance to today’s AAL bet, I could sell calls in the iShares Dow Jones Transport. Avg. (ETF) (NYSEARCA:IYT). For example, I could collect $1.20 for selling the Sept $183 call with 90% theoretical certainty of success.
Email sellspreads@gmail.com with questions or join me to learn more about options in a personal 1on1 webinar here. 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. You can follow him on Twitter at @racernic and stocktwits at @racernic.
