American Airlines (NYSE:AAL) dropped 8% on May 28 after reporting earnings. Clearly investors have not yet come to terms with all of the woes that the industry is facing. This also put pressure on Southwest Airlines (NASDAQ:LUV), which fell 3% on Thursday and some more this morning. But it hasn’t all been bad news in the price action of airline stocks. In just nine days, LUV stock rallied as much as 56% off of the $22.50 bottom. This shows that the fan base is still alive. However, the easy work is done, but for the long-term, the opportunity still exists.
The quarantine caused a panic on Wall Street, especially over the travel and hospitality industries. Even the most famous investor Warren Buffet of Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) closed out of his airline positions. This caused carnage among the group on two occasions.
First, when the headline broke out, they sold millions of shares, then again when they announced selling the remainder of the shares. Right or wrong, this mattered because he earned his “Oracle” moniker for good reasons.
For today’s discussion, those who are looking to own Southwest shares for the long-term shouldn’t worry about finding the perfect entry point. The Covid-19 dip created a good enough opportunity in general regardless of where the absolute bottom lies. Most traders, on the other hand, prefer getting into stocks right, so it makes sense to try and avoid making the obvious mistakes.
Ignore the LUV Stock Fundamental Metrics
The fundamentals of the whole industry have changed and perhaps forever. As with most airlines, the usual metrics look cheap, but in reality, they are temporarily useless to investors. Air traffic is still down 90% from its usual levels, so it would be ridiculous to use the price-to-earnings value of 9 to determine value on any airline stock. At the depth of the correction, the concern was company survival. Wall Street feared that major U.S. airlines were at risk of death. Even Boeing’s (NYSE:BA) CEO recently expressed this opinion in an interview with NBC.
Luckily, we are going into an election season, so the White House was not going to let any high-profile American corporation fold. The industry got the bailout it needed to weather the storm. Now the priorities are to cut costs until money starts flowing through their income statements. They are starved for sales and the reopening process cannot happen fast enough.
Good News for LUV Stock?
Another bit of good news came this week when Boeing announced it’s restarting some of its 737 Max production. This is especially important for Southwest because its entire fleet consists of 737’s, albeit not all of them are Max models. The more lingering hindrances that end, the easier the recovery stage becomes. This is all to say that the worst of this crisis is over for LUV stock. Investors who held their shares throughout should not panic now. For peace of mind, equity owners can use the options markets to rent some insurance.
Technically, the stock has resistance going into $38 per share. This alone is not a reason to short it. In fact, small failures would make for smart entry points near $30. Then the bulls will have the opportunity to wage another rally to attack necklines with more force and target $43 per share. It will take patience and a lot of hard work from the buyers. Because every level that they tried to hold on the way down will act as resistance on the way back up.
Management Will Face a New Normal After this Crisis
They say that what doesn’t kill you, makes you stronger and this was as tough a test as they come. Eventually, LUV stock will emerge from this as a sector leader once more. Management we’ll have to continue tightening their purse strings until the financial situation improves. They have been in trouble so many times before that they know how to cut costs. Case in point is what American Airlines’ Parker said about his plans to trim more fat. But they also have to adjust to what ever new rules may come. They won’t be allowed to stuff the planes like they did into February. Also, there aren’t any perks left, so prices may have to rise. The first step is for people to start flying again and sooner rather than later.
Right or wrong, consensus is that they will soon find a vaccine. Investors have already priced those scenarios in. They will boost stock prices again until the actual headline hits. Meanwhile, there still is considerable risk of potential hiccups from loosening the quarantine. We are now at the edge of the virus incubation period. Meaning if infection were to reemerge they would have started showing signs by now.
A Twist on the Old Buy-and-Hold
Volatility is still high, so it’s prudent to use caution. One way to do this is to use options. For example, instead of buying shares, investors sell the LUV September $22.50 put and collect $1.5 per contract. They don’t even need a rally to profit. In fact, the stock can even fall another 35% from here before they lose any money. They break even at about $21 per share. This allows investors to be long a stock, while leaving room for error. But remember, it is important to never sell puts, except for the purpose of owning the stock, and to never take a bigger risk than what you’re willing to lose.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room for free here.