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On Monday morning, I purchased some United Continental Holdings Inc (UAL) January 2013 $23 calls for 28 cents. There are three reasons why I purchased calls on UAL.

1. Oil Prices Have Moved Sharply Lower

Over the past three months, oil prices moved rather sharply lower. For all airlines, US Airways (LCC), Delta (DAL), Southwest (LUV), Jetblue (JBLU), and others the drop in oil prices should prove a major positive. In mid September, following the announcement of QE3, I argued that shorting airlines might be a good way to play higher oil prices. Since then, oil prices have moved sharply lower, not higher as I had anticipated following QE3. However, despite the move lower in oil prices the rally in airline stocks has been relatively muted. As shown by the chart below, the only airline to take flight has been US Airways.

LCC ChartLCC data by YCharts

Compared to the other major airlines, UAL shares have moved higher by the least. This is just one reason why I decided to buy calls on UAL instead of its peers.

2. Short Interest

Currently, short interest in UAL stands at 32.6 million shares or 11.1% of the float. The high short interest means that a short squeeze is certainly possible given a strong end of year travel season. Comparably, short interest in Delta is less than 1% of the float. It should be noted that both US Airways and Jetblue have higher short interests than UAL. However, there are other reasons why I choose to avoid those names. For Jetblue, I viewed the lack of liquidity in the options as a problem. As I write this, only 40 options contracts have traded so far in the Jetblue January options. Comparably, as I write this, nearly 400 January call options have traded so far in UAL. Clearly, UAL options are more liquid than JBLU and thus easier to get in and out of.

3. US Airways and American To Merge?

For a while now, rumors of a merger between American Airlines and US Airways have been circulating. Some have said that a merger could come as soon as January. Of course, nothing is certain and a deal may not happen but I think a deal of some sort is likely between American and US Airways. Some would argue that the best way to play a potential deal is by buying US Airways. However, after reading this piece I have decided that a merger may not be all that great for US Airways shares. A more certain beneficiary of a merger between US Airways and American would be other airlines as a merger would been further decreases in capacity which should allow for better pricing power throughout the industry. I expect UAL shares to benefit at least in the short-term if a merger is announced.

Conclusion

I bought UAL calls for a variety of reasons. Firstly, UAL's failure to move higher despite falling oil prices leads me to believe that the stock could be a coiled spring right now. Additionally any agreement between US Airways and American should be bullish for the whole industry including UAL. Finally, the high short interest means a squeeze is possible given any possible news. By January expiration, I would not be surprised to see UAL trading at a new 52 week high, above $25.84. In that case, my $23 calls should be well positioned to benefit.

Source: 3 Reasons I Bought United Continental Calls

Additional disclosure: I am long UAL January 23 calls