Market Overview
Very impressively, the rally that started late in 2022 continued last week, as the S&P 500 gained 2.7%, the Dow rose 1.8%, and the Nasdaq tacked on another 4.5% of gains. Maybe, just maybe, the bulls are back in charge.
This week we are executing a covered call on a company that raised guidance just last week, and in a sector that has been very strong since the start of the year.
The Stock – American Airlines (AAL)
Why the Strength
Two and a half years ago the airline industry was on its knees as the pandemic slashed air travel to nearly zero, but now the pendulum has swung completely in the other direction—travel demand has nearly caught up with pre-pandemic levels while industry capacity remains relatively tight for a few reasons. Throw in cost cuts and recent fuel price declines and analysts see earnings and cash flow going through the roof in 2023 — and some insiders (like Delta’s CEO) think it could take years to catch up with demand.
American Airlines is one of the big players in the group, of course, and all of the above factors are coming together to produce great results. Just last week, the top brass meaningfully raised guidance, with the Q4 outlook now for revenue to rise 16.5% compared to the Q4 2019 (pre-pandemic) levels, even as capacity is down 6% from that time, with earnings in the $1.15 per share range. (It did get some benefit from Southwest’s cancellation horror show, with passengers scrambling for alternatives.)
As for the company itself, management also said it’s on the back end of an investment cycle (less CapEx), which should allow for big cash flow and rapid deleveraging; the firm has a goal of cutting debt by $15 billion by 2025, but it’s already halfway there, slashing interest costs that should flow to the bottom line. Analysts see earnings of around $1.74 per share this year and $2.75 next, but if recent trends hold, those could both prove very conservative as the post-pandemic travel boom continues. It’s an intriguing stock and group move. Earnings are due January 26.
Technical Analysis
Despite the fundamental improvements, AAL was stuck in the mud last year, with the stock dipping to the 12 area or below in June, September/October and again in December—basically the same zone the stock was sitting at in the summer of 2020 when everything was at a fundamental standstill. But it’s hard not to look at the last two weeks as a big change in character—AAL (and most peers) have rocketed higher on giant volume, with the firm’s Q4 update last week helping; impressively, shares shook off Delta’s good-not-great guidance on Friday. Yes, it’s extended, but we’re thinking pullbacks will be contained. Stop - 14
The Covered Call Trade
Buy American Airlines (AAL) Stock at 17.5, Sell to Open February 17 Strike Calls (exp. 2/17) for $1, or a Net Price of 16.5 or less
Static Return: $50 per covered call (3.03%)
Breakeven: 16.5
Covered Call Return (if assigned): $50 per covered call (3.03%)
Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.
However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 16.5 or less. (In this case 17.5 minus 1 = 16.5. Or another example is you could pay 17.4 for the stock and sell the call for 0.90, which also equals 16.5)
For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …
Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.
The next Cabot Profit Booster issue will be published on January 24, 2023.
