It's A Good Time To Play Options With Airliners

Includes: AAL, ALK, DAL, LUV
by: Jacob Steinberg

Airline companies are unique in many ways. They are cyclical, volatile and prone to bankruptcies. Airline industry is affected by many outside factors such as the overall economy, global trends, oil prices, labor market, regulations and issues or threats related to war and terrorism. Many different factors must come together before an airline company becomes successful. Interestingly enough, now is a good time to buy shares of airline companies and sell covered calls on these shares.

You may wonder why now is a good time. First of all, this is a time when many airline companies posted stronger than expected results. Many airline companies had recent rallies, yet their P/E ratios are low compared to historical standards. For example, Delta Airlines (NYSE:DAL) enjoys a trailing P/E ratio of 7 and forward P/E ratio of 6, whereas the company's historical average is well above 10. US Airways (LCC) enjoys a trailing P/E of 9 and forward P/E of 6 despite a recent rally that moved the stock price up by more than 80% in the last 6 months. Alaska Air Group (NYSE:ALK) has a trailing P/E of 11 and future P/E of 7.

As the oil price goes up and airline costs increase, airlines pass these costs to costumers in shape of different fees such as baggage fees. Because flying doesn't have many feasible alternatives, people usually put up with these fees. Considering most destinations, driving, or even taking the train is still costlier than flying.

Now let's take a look at covered call yields in some of the airline companies. My favorite airline company when it comes to yields is US Airways. Currently the company trades for $11.01. If one bought the stock today and sold calls expiring in June with a strike price of $11.00, the premium would be 92 cents. In fact this is exactly what I did today, however I bought the stock for $11.10 and my premium for the call was $1.03 per share. This provides the investor with a yield of 8.26% if the stock ends above $11 by the third weekend of June, or a yield of 8.35% if the stock price is below $11 by then. This provides a protection until the stock price falls below $10.09. If the stock falls below this level, you can always keep the stock and issue more options. I think 8.26% is a pretty good yield for a month and half as many fund managers fail to get such yield in a year. Because the momentum is positive for LCC at the moment, I don't expect the stock price to plunge anytime soon. A strike price of $12 provides with a premium of 54 cents per share, a yield of 4.50%. Even this can show the positive vibes around this company in the short term.

Delta Airlines currently trades for $11.17. June calls with a strike price of $11 result in a premium of 71 cents. This means the yield will be either 4.84% or 6.35% depending on where the stock price lands by June 16th. One can also pick a strike price of $12 and get a premium of 29 cents per share. Southwest Airlines (NYSE:LUV) trades for $8.26 and the company's June calls with a strike price of $8 bring in a premium of 50 cents per share. This is a yield of 2.91% if the strike price is met, or a yield of 6.01% if the strike price is not met by the time of expiration.

Now I don't recommend buying an airline stock and holding it for 10+ years as these companies have the habit of going bankrupt and destroying their stockholders, but it is relatively safe to buy and hold one of these stocks for a year or two. I like the idea of selling covered calls and I do this with almost every stock I hold in my portfolio. It provides with protection against downside and current income. With help of covered calls, it becomes much easier to beat the market along with many professional fund managers.

Disclosure: I am long LCC. I wrote covered calls with a strike price of $11, expiring on June 16th.