Southwest’s pullback – providing opportunity
For option sellers, volatility is your friend.
Southwest Airlines (LUV, Financial) reported a mixed bag of results on Thursday morning. EPS came in at $1.28 gross, or $1.19 adjusted for non-recurring items, versus a consensus estimate of $1.21. Load factor improved to 85.6%.
Pressure on fares from increased industry capacity and fuel prices averaging $2.02 per gallon tempered otherwise excellent results. Computer glitches at its Pittsburgh hub caused delay or cancellation of more than 200 flights from that city today as well.
That combination caused the stock to react badly. LUV briefly dipped as low as $37.27 before rebounding a bit.
At 9:43 AM, with LUV at $37.92, the shares fetched only about 9.5x this year’s estimate. That compares very favorably with the stock’s post-recession average P/E of 15.8x. Southwest’s 10-cent quarterly dividend now provides a 1.06% yield, almost 80% better than its typical payout over the previous six years.
Traders who liked LUV, and were quick on the trigger, captured great put premiums on the Janunary 2018 puts at $35, $38 and $40 strikes. Out-of-the-money, 18-month $35 puts drew $4.30 premiums, dropping the “if exercised” forced purchase level to just $30.70.
I was able to get as high as $5.60 for the $38 strike lowering break-even to $32.40. Sellers of the more aggressive $40 puts received $6.70 while locking in a worst-case purchase price of $33.30.
Thurday morning’s actual bid-ask prices along with a chart dating back to Jan. 1, 2015, show how rarely LUV has trended south of the break-even price on the middle-of-the-road $38 puts. That happened on only a few days during the past 19-months.
Since 2011, Southwest's EPS has grown from 43 cents to an estimated $4.00 in 2016.
Why be scared to own stock in an industry leader, near the best prices of the last couple of years? LUV traded as high as $48 YTD in 2016 and set an all-time high of $51.34 less than one year ago.
Disclosure: Short LUV Jan. 19, 2018, expiration date $35 and $38 puts.
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