When it comes to airline options, implied volatility loves to fly – and it shows!
DAL - Delta Airlines (DAL) shares hived off 13.5% of their value to set a new 52-week low of $7.11 this morning, amid concerns that it may be forced to hike ticket costs to defray rising fuel costs despite its announced merger with Northwest – an alliance that itself is arousing antitrust vagaries. Later this week, CEOs of Delta and Northwest (NWACQ) will address members of Congress as the U.S. Justice Department mulls whether to approve the celebrated merger. Implied volatility rose by more than 20% this morning to read 118% - an angry elevation above the 102% historic reading. With the equivalent of nearly 30% of its open volume in play, we observed what appeared to be a 65,000-lot call spread between strikes 7.50 and 10 in the September contract. The likeliest scenario for this kind of spread would be a trader buying the lower-strike calls for $2.05 and selling the $10 calls for $1.00, resulting in a transaction that would break even at $8.50.
UAUA –Unlike its sector peers Delta and Northwest, United Airlines’ parent company UAL (UAUA) has no imminent merger to mitigate its exposure to spiraling fuel costs, and it was this vulnerability that cost the airline more than a third of its share price today to read $14.25 over the noon hour. The implications of the earnings miss rippled bearishly throughout the market. Despite assurances from United’s parent company that it would move to reduce flights and personnel overhead costs, the option market responded in short order, sending volume to 7 and a half times the normal level, and twice as many puts in play as calls. Buying interest we observed at the May 22.50 call strike for $1.20 only makes sense in this context if entered as a long volatility play with, for example, the 15 puts, which were also heavily bought today. Long volatility plays are a fairly stunning commentary on the market’s immediate reaction to the earnings miss – implied volatility on all UAL options rose by more than 70% on the news and the current 147% reading suggests 88% more price risk to the airline’s shares than it has already charted.