Soaring American Airlines, Southwest Airlines Provoke Bullish Options Betting

American Airlines Group Inc (NASDAQ:AAL) and Southwest Airlines Co (NYSE:LUV) options are flying, as the airline stocks trek higher

by Alex Eppstein

Published on Sep 7, 2016 at 2:45 PM

According to our internal Sector Scorecard, airline stocks are in a good position to fly. Two-thirds of the stocks we cover in the "Aerospace Airlines" sector are above their 80-day moving average, plus the average 52-week return among these names is 9.5%. Despite this, short interest has exploded 23% higher year-over-year, suggesting there's proverbial fuel left in the tank. Two names making good on this upside potential today are American Airlines Group Inc (NASDAQ:AAL) and Southwest Airlines Co (NYSE:LUV).

The sector is getting a lift after LUV said it plans to slow capacity growth next year, which could positively impact revenue. Plus, Delta Air Lines, Inc. (NYSE:DAL) Chief Financial Officer Paul Jacobson said industry sales trends have been improving, adding, "We see a lot of signs, reasons to be optimistic." All told, the Dow Jones Transportation Average (DJT) is on track for its biggest percentage gain in a month, adding 1.4%.

Diving into stock-specific performance, AAL has soared 5.7% to $39.06 to test its 320-day moving average for the first time in 2016. Since bottoming in late June at $24.85, the shares have advanced a brow-raising 57%. Meanwhile, the stock's call options are changing hands at triple the expected clip for this point in the afternoon, with potential buy-to-open activity detected at the weekly 9/9 38 strike -- the equity's most active option so far.

This represents a sharp break from the prevailing trend toward puts, seen across the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). During the past two weeks, traders have bought to open 1.25 puts for every call on AAL, and that ratio ranks just 1 percentage point from an annual peak. While some puts may have been purchased by shareholders hedging, a capitulation among "vanilla" bears could translate into tailwinds.

Plus, as stated previously, an unwinding of short interest could act as another positive catalyst for American Airlines Group Inc. Specifically, the stock's short-interest ratio is 5.80, meaning it would take more than a week for shorts to cover their bearish positions, at AAL's typical volumes.

Turning to LUV, the shares are up nearly 5% at $38.76, and on track for their highest close since gapping lower on earnings in late July. Meanwhile, the stock's options pits are in overdrive, with calls running at quadruple the anticipated intraday rate, and about five times the pace of puts. In the lead is the January 2017 38-strike call, and from the looks of it, traders are purchasing new positions here, confident in the shares' long-term prospects.

By no means are these the only option bulls on Wall Street. Southwest Airlines Co sports a 10-day ISE/CBOE/PHLX call/put volume ratio of 4.91, with long calls nearly quintupling puts. Furthermore, the ratio sits in the top quartile of its 12-month range, suggesting options traders have been more bullish than usual. Of course, given that short interest jumped 28% in the most recent reporting period, it's also possible calls were purchased by short sellers seeking protection against a sharp upside move -- not unlike the one we're seeing today.

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