Put Spread Trading Strategies in Southwest Airlines (LUV)
Southwest Airlines (NYSE: LUV) spiked higher this week after JP Morgan Chase upgraded its rating on the shares to “overweight” (buy) all the way from “underweight” (sell). The broker noted the discount carrier is “learning the art of price discrimination” and capturing business from its competitors.
LUV, an exclusively domestic carrier, has not been affected by flight cancellations related to the volcanic explosion in Iceland. Other airlines are losing millions of dollars every day while European airports are closed.
LUV has continued to trend steadily higher since last March, gaining about 175% during this time, touching a new 52-week high of $13.95 in early trading Monday. Over the past several weeks, however, the stock’s upward momentum slowed somewhat as the shares have consolidate in the 13-14 area.
While brokers are limited to the buy-hold-sell scale, option strategies weigh additional factors such as volatility and timing. Whether you agree with JP Morgan’s bullish outlook or think LUV may have run up too far, too fast, there could be an options strategy that matches your risk/reward profile. Below are two hypothetical trades that are not buy-sell-hold recommendations, just examples of how different options strategies work.
Note that LUV is scheduled to report earnings on April 22, and analysts are expecting the firm to make two cents per share, an improvement over Southwest’s year-ago loss of three cents per share. Due to the possibility of price volatility surrounding the earnings announcement, conservative investors may want to wait on the sidelines until this event passes.
*Prices given as of Monday afternoon
Bullish Option Strategy: Bull Put Spread
Agree with JP Morgan’s rationale? You may want to look into a short-term bull put spread. The June 14/12 put spread can be sold for 60 cents or more by buying the 12-strike put and selling the 14-strike put. If LUV moves slightly higher and is trading above 14 when these June options expire, the spread seller keeps the entire 60 cents collected as profit. The reverse side of this coin is the maximum potential loss of $1.40, achieved at expiration if LUV falls south of the $12 level.
Breakeven on this trade is $13.40, providing a slight bit of downside from current levels. For this relatively conservative strategy, the spread seller doesn’t need the shares to rally; he just needs them to not decline.
Bearish Option Strategy: Bear Put Spread
Investors who think LUV is ripe for a reversal might consider the opposite strategy – a bear put spread. The September 13/14 put spread can be purchased for 45 cents by buying the in-the-money 14 put and selling the out-of-the-money 13 put. If the stock moves lower and is trading below $13 at expiration, the spread buyer collects the maximum potential profit of 55 cents. At risk, meanwhile, is 100% of the premium paid (45 cents), which transpires if LUV is trading above $14 at September expiration.
Breakeven for this trade is $13.55; if LUV is trading anywhere below this level when the options expire, the spread will be profitable. Of course, these options do not need to be held all the way until expiration and an investor may choose to exit early in order to take profits or contain losses.
What is Your Strategy for LUV?
Do you love LUV or do you think its days of continued upside are numbered? Do you have thoughts on the overall airline sector as a whole?
Photo Credit: stevesheriw
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