As vaccination efforts in the US and some other countries begin to lower infection rates in some regions, the share of travel and leisure businesses, including airlines, has begun to recover from their pandemic lows. There are also expectations for an increase in the number of summer trips and related bookings.
So today we're looking at Texas-based American Airlines (NASDAQ 🙂 whose stock is up 38.1% since the start of the year after losing 45% in value in 2020 . In March, AAL shares reached a 52-week high of $ 26.09 and is now hovering at $ 21.7.
Weekly chart from American Airlines.
Similarly, the index and index have risen more than 15.8% and 27.3%, respectively. As of early 2021, the shares of Delta Air Lines (NYSE 🙂 and United Airlines (NASDAQ 🙂 and the much-followed exchange-traded fund (ETF) U.S. Global Jets ETF (NYSE 🙂 have returned approximately 15.4%, 24.1% and 17.2%, respectively.
On April 22, American Airlines released Q1. Following the report, investors hit the "buy" button – shares are up about 15% since then. Now many are wondering what the future could be for the stocks. Will prices rise or will profits be made in the short term?
In recent weeks, we have discussed how investors might consider writing covered redemptions on their holdings, especially those that have recently appreciated in price. Today we look at American Airlines and give an example of a covered conversation.
Such an options strategy could help reduce the volatility of their position and provide shareholders with some protection against potential falls. Readers new to options may want to revisit the first article in the series before reading this post.
American Airlines Group
Intraday Price: $ 21.67
52 Week Range: $ 8.25 – $ 26.09
Price change year-to-date: up ~ 38.1%
Legacy carrier American Airlines operates hubs in Charlotte, Chicago, Dallas / Fort Worth, Los Angeles, Miami, New York, Philadelphia, Phoenix and Washington, D.C. It is also a founding member of the Oneworld Alliance.
The global proliferation of COVID-19 has caused a severe drop in air travel demand, negatively impacting the company's Q1 statistics. Sales were $ 4.0 billion, down 53% year-on-year. A net loss of $ 2.74 billion translated into a loss of $ 4.32 per share. The company closed the first quarter with total available liquidity of $ 17.3 billion.
During the pandemic, American Airlines, like other airlines, put significant debt on its balance sheet. The Street was pleased to learn that the management does not intend to raise any more money. The airline has delivered more than $ 1.3 billion in permanent non-volume cost reductions for 2021.
CEO Doug Parker commented:
“We are seeing signs of continued recovery in demand. We remain convinced that the network enhancements, customer-facing improvements and efficiency measures we have taken will ensure that American is well positioned for the recovery. "
Management now predicts that capacity in the second quarter will be 20-25% lower than in the second quarter of 2019. Likewise, revenues in the second quarter are likely to decline by 40% year-on-year. The airline expects to close the second quarter with $ 19.5 billion in liquidity.
Given the significant rise in the AAL stock price in recent months and since the release of the Q1 results, a covered call may be a suitable strategy for some investors who want to protect at least a portion of their profits.
Covered Calls on AAL Shares
For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date at some point in the future.
On Tuesday, AAL shares traded at $ 21.67 during the day. That's why we use this price for this post.
A stock option contract on AAL (or any other stock) is the option to buy (or sell) 100 shares.
Investors who believe that short-term profits could be taken soon, could use a somewhat in-the-money (ITM) covered call. A call option is ITM if the market price (here $ 21.67) is higher than the strike price ($ 20.00).
Thus, the investor would buy (or already own) 100 AAL shares for $ 21.67 and simultaneously sell an AAL call option dated June 18, 2021, 8:00 PM. This option is currently being offered at a price (or premium) of $ 2.52.
A buyer of an option would have to pay $ 2.52 x 100 (or $ 252) in premium to the seller of the option. This call option will stop trading on Friday June 18, 2021.
This premium amount belongs to the option writer (seller) no matter what happens in the future, for example on the day of expiration.
The 8:00 pm strike offers more downside protection than a phone call for money (ATM) or out-of-the-money (OTM).
Assuming a trader would now participate in this covered call trade at $ 21.67, at expiration the maximum return would be $ 85.00, i.e. ($ 252 – (($ 21.67 – $ 20.00) x 100)), excluding trade commissions and fees.
Risk / Reward Profile for Uncontrolled Covered Call
The maximum profit of an ITM covered call is equal to the extrinsic value of the short call option.
The net asset value would be the tangible value of the option if it were exercised now. Thus, the intrinsic value of our AAL call option is ($ 21.67 – $ 20.00) X 100, or $ 167.
Extrinsic value is the difference between the market price of an option (or its premium) and its intrinsic price. In this case, the extrinsic value would be $ 85 i.e. ($ 252 – $ 167). Extrinsic value is also called time value.
The trader realizes this $ 85 profit as long as the price of AAL stock at expiration remains above the strike price of the call option (i.e., $ 20.00).
At maturity, if the stock closes below the strike price, the option would not be exercised, but would instead expire worthlessly. Subsequently, the shareholder with the covered call position receives the shares and the money (premium) that he / she paid for the sale of the option.
At maturity, this transaction would break even at an AAL stock price of $ 19.15, excluding trading commissions and fees.
Another way to think of this break-even price is to subtract the call option premium ($ 2.52) from the underlying AAL stock price when we initiated the covered call (i.e. $ 21.67).
On June 18, if the AAL shares close below $ 19.15, the transaction would begin to lose money within this covered call setup. Thus, by selling the covered call, the investor has some protection against a potential loss in the event of a fall in the underlying stock. In theory, the price of a stock could fall to $ 0.
What if AAL shares hit a new 52-week high?
As we noted in previous articles, such a covered call would limit the upside profit potential. The risk of not fully participating in the potential appreciation of AAL shares would not appeal to everyone. However, within their risk / return profile, others would find that acceptable in exchange for the premium received.
For example, if the AAL stock hit a new high in 2021 and close at $ 40 on June 18, the trader's maximum return would still be $ 85. In that case, the option would be deep ITM and likely exercised. A brokerage fee may also be charged if the shares are called away.
As part of the exit strategy, the trader could also consider rolling this deep ITM call option. In that case, the trader would buy back the $ 20.00 call before it expired on June 18.
Depending on his / her opinion and objectives regarding the underlying AAL stock, he / she might consider starting another covered call position. In other words, the trader could potentially roll out to a July 16 maturity call with an appropriate strike.
Bottom Line
More than half of American adults have had at least one dose of a COVID-19 vaccine. We can therefore expect a further recovery in air travel, especially in the summer months. But Wall Street is looking ahead. Most of the expected positive news has likely been reflected in airline stock prices, including AAL stocks.
The exact market timing at which AAL stocks could take a breather is difficult to determine, even for professional traders. But options strategies provide tools that can prepare for sideways moves or even price declines, especially around the earnings release date.
We consider covered call options as a possible way to generate additional income from your equity portfolio. Such a strategy also helps reduce portfolio volatility. Interested investors might consider expanding their knowledge base.
