DAL & UAL: Mile High Club

by Dan December 28, 2015 3:07 pm • Commentary

2015 started with the promise that lower oil might heal the ills in our low growth economic recovery. This has obviously not been the case in many sectors, and particularly in our consumer led economy with most retail stocks struggling (with notable exceptions Apple, Amazon, Home Depot, Nike & Starbucks).

The airline industry was another sector that would benefit from lower oil as fuel is a major input cost, especially at a time when most large carriers are enjoying the benefits of recent merger synergies and strong demand for lower capacity.

Some air carriers have, with those deemed to be largely domestic like Alaska Air (ALK), Jetblue (JBLU) and Southwest (LUV) all recently at 52 week highs just weeks ago (now up 37%, up 47% and up 4% respectively on the year), prior to disappointing November passenger data.  But investors have not been nearly as kind to the big three, American Airlines (AAL), Delta (DAL) and United Airlines (UAL), down 19%, up 5% and down 11% respectively on the year. The big difference here is that AAL and DAL get about two thirds of their sales from the U.S., and UAL about 55% vs ALK & LUV at 100%, while JBLU sales outside U.S. are in only in the Western Hemisphere.

The exposure to the strong dollar and emerging markets spooked airline investors causing them to crowd into the stocks of a handful of domestically focused carriers, while disregarding for the most part those who will rely on international routes for future growth (like UAL.)

But the out-performance of DAL, among the majors, is nothing short of impressive.  First and foremost it has the largest market cap of all of the stocks listed above $14 billion, equal to its expected 2015 sales.  For the better part of 2015 shares of DAL have traded between $40 on the downside and $50 on the upside, having just this month broken out to a multi-year high:

DAL 2 yr chart from Bloomberg
DAL 2 yr chart from Bloomberg

Now looking at UAL, a $22.5 billion market cap vs an expected $38 billion in sales, .6x sales vs DAL at 1x.  UAL has held the uptrend that has been in place since late 2012, has consolidated of late in the high $50s, and is now threatening a breakout above the downtrend that has been in place since its highs in Jan.  While there is little overhead technical resistance until the high $60s, there is little support to the low $50s, back near the uptrend:

UAL 3yr chart from Bloomberg
UAL 3yr chart from Bloomberg

Options prices in UAL are quite cheap, despite the stock’s poor relative and absolute performance, with 30 day at the money implied volatility at 35%, below the 52 week highs of 56% in February, and the one year average of 38%:

UAL 1yr chart of 30 day at the money Implied Volatility from Bloomberg
UAL 1yr chart of 30 day at the money Implied Volatility from Bloomberg

So What’s the Trade?  

United (UAL) – Bullish Q4 Earnings Trade 

UAL ($58.90) Buy the Jan 15th regular/ Jan 22nd weekly 62.50 call calendar for .40

-Sell to open 1 Jan15th regular 62.50 call at 40 cents

-Buy to open 1 Jan22nd weekly 62.50 call for 80 cents

Break-Even on Jan15th regular expiration: maximum profits at 62.50 on January expiration, losses if the stock is significantly higher or lower than 62.50. Once January regular calls expire, the expiration week calls can either be spread or left alone as they will only have cost .40 and have unlimited potential if the stock goes higher on earnings.

Rationale: UAL is in a slightly more precarious spot from both a sentiment, fundamental and technical set up than DAL (we’ll get to that one in a minute).  So for those targeting Q4 earnings that should fall the week of Jan 18th, we think it makes sense to try to finance out of the money calls in weekly Jan22nd expiration that will catch the event. This trade risks only .40 with unlimited potential into the event once the Jan regulars expire.


Delta (DAL) – Bullish Q4 Earnings Trade 

Since DAL is on the edge of breaking out it is a candidate for a stock alternative or replacement. If it fails, the risk is defined, and if it does breakout this sort of strategy can closely mimic being long stock.  The next identifiable catalyst will be earnings that should fall the week of Jan 18th.

A simple stock alternative is buying a Jan in the money call butterfly in Jan 22nd weekly expiration:

In lieu of 100 shares of DAL ($51.95) Buy the Jan 22nd 50/55/60 call butterfly for $1.80

-Buy to open 1 Jan22nd 50 call for 3.10

-Sell to Open 2 Jan22nd 55 calls at .70 each or 1.40 total

-Buy to open 1 Jan22nd 60 call for 10 cents

Break-Even on Jan expiration:

Profits:  up to 3.20 between 51.80 and 58.20, with max gain of 3.20 at 55

Losses: up to 1.80 between 50 and 51.80 & between 58.20 and 60 with max loss of 1.80 or 3.5% of the stock price below 50 or above 60.

Rationale: This defines risk in the stock in the event of a failed breakout (if it does it defines $50 as a level with no losses below), while targeting a realistic breakout to $55. The downside to the stock alt is total intrinsic gains with the stock higher from here aren’t realized until after the event so decisions may have to be made depending on where the stock is into the event, especially if it’s above the 55 strike as profits trail off above that point. The risk/reward is good, risking 1.80 to make 3.20.