Event: DAL reports its Q4 earnings on Tuesday before the open. The options market is implying about a 5% one day move, which is above both the 4 qtr avg of about 4.5% and the 8 qtr avg of about 3.5%.
Sentiment: Wall Street analysts are very positive on the stock, with 18 Buys, 1 Hold and No Sells, with an average 12 month price target of around $36. That positive outlook is even after the stock has more than doubled over the past year. The short interest in DAL is only 1.8%, and DAL stock has risen in 15 of the past 17 months.
Options Open Interest: Open interest is slightly skewed towards calls, by a ratio of 1.15 to 1 (402k vs. 347k). Recent activity has been skewed towards calls by a much greater margin, with a one month average call to put ratio of 2.75 to 1. With Jan18th options expiring today, the short-term strike with the most open interest is the Feb 32 call, which has nearly 20k of open interest. The March 30 calls also have nearly 20k of open interest, while the March 26 puts have over 12k of open interest.
Price Action / Technicals: DAL has been in a huge uptrend since its breakout above $15 in early 2013:
[caption id="attachment_34927" align="alignnone" width="600"]
DAL weekly chart, Courtesy of Bloomberg[/caption]
Since DAL is essentially at an all-time high (after coming out of bankruptcy in 2007), there is no meaningful resistance. Short-term support lies around the November high and the rising 50 day moving average, in the $28.50-$29.50 zone. With options implying a 5% move, that means a move back down to that support, or a breakout to new all-time highs.
Volatility: Implied volatility in DAL is relatively low ahead of the earnings event, which is especially surprising since recent realized volatility has been quite high on January’s rapid rally. Implied vol is actually at its lowest level ahead of earnings over the past 2 years:
[caption id="attachment_34935" align="alignnone" width="600"]
DAL 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro[/caption]
Part of the reason for the decline in implied volatility is the overall increase in DAL stock, which implies stability and fundamental strength for the company. But at a new all-time high, and with high realized volatility, options might be attractive if implied vol falls below 30 after the earnings report.
Our View: Airlines have been one of the best performing sectors over the past year, as the consolidation in the industry in the past decade has led to pricing power coupled with demand growth. Valuations are still quite reasonable (DAL at about 13x 2014 estimates), but part of that is because investors are wary of the historical earnings volatility for airlines.
Moreover, expectations are quite elevated, as noted by GS Research:
Strong pricing in December has underpinned significant revisions of +24% among the US airlines. As the sector has rallied 7% since December 1, we believe the good news is largely discounted. While we have a relatively constructive view for 2014, inclement weather in January will likely weigh on initial guidance and may lead to short-term profit taking, creating an opportunity to accumulate on weakness. Consensus estimates look high to us.
With this backdrop, options pricing looks expensive, especially a couple months out. We don’t want to trade ahead of the event ourselves, but might look at a position in volatility after the earnings announcement next week.