Trading Oil and Airlines

Today was an active trading day establishing 3 new positions and closing out one existing position. Two of the positions that I entered today may seem a bit unusual as they do not fit the typical trading pattern that I have followed since beginning this blog. After tweeting out the trades, I received several comments which prompted me to offer more detail than can be accomplished through Twitter.

SkyWest Airlines (SKYW)

CRJ700-2-1The first trade that I placed this morning was in SkyWest Airlines (SKYW). This is a company that I am intimately familiar with having been previously employed by SkyWest for nearly ten years as a pilot. It is a very conservatively managed company which has allowed it to flourish and become the top regional airline in the industry. On April 30th, it announced its first quarter results which significantly beat estimates sending the stock up by over 18%.

Over the past several days, the airline sector has been hit hard over concerns that the U.S. Government will not intervene to stop three Persian Gulf airlines from expanding service in the U.S. which would result in more competition and capacity in the U.S. market. Overcapacity results in lower fares and lower revenues for airlines.

SkyWest is a contract carrier that operates smaller regional jets along routes that cannot be profitably flown by their major airline partners.  Currently, SkyWest serves United Airlines (UAL), Delta Airlines (DAL), US Airways, American Airlines (AAL) and Alaska Airlines (ALK).

Overall, I like the stock at its current price. I have owned it in the past and would not mind having it in my portfolio again. It is a relatively inexpensive stock. I would not normally suggest this underlying for options trades due to the fact that both the stock and the options do not have great liquidity. However, if one is willing to hold the stock for the long-term (should the need arise), I think the trade is worthwhile.

Trade Details:

BUY 100 SKYW @ 14.71
SELL 1 SKYW Jun 15 15 Call @ .43
Days to Expiration: 23

If the stock is called away within the next 23 days, the trade makes $72.00. The stock only requires $735 of capital in a margin account, so this would result in nearly a 10% return on capital. Not too shabby, considering the fact that the stock would not need to rebound much for this to occur. On the other hand, if the stock is not called away, I have reduced my cost basis to $14.28 per share and can sell another call next month to reduce cost basis further. The risk, of course, is that the stock continues the trend downward.

Chart_052715_SKYW

 

SPDR S&P Oil & Gas Exploration ETF (XOP)

Readers of this blog know that I enjoy trading oil, usually in the form of crude oil (/CL) futures options. Each /CL futures contract has a notional value of approximately $60,000 at today’s prices. That can be intimidating for an inexperienced trader. Another way to trade oil is via the United States Oil Fund (USO). Unfortunately, USO experiences a negative drag which is often a characteristic of futures based derivatives. Due to this drag, a bullish position in USO can result in a loss even when your directional assumption is correct and crude oil prices move up.  Another oil-related ETF that can be easily traded is XOP.  XOP does not exhibit the same negative drag tendencies as USO since it is not directly based on the /CL futures contracts.

Trade Details:

SELL 1 XOP Jul 15 49 Put @ 2.07
SELL 1 XOP Jul 15 49 Call @ 2.45
BUY 1 XOP Jul 15 52 Call @ 1.12
Credit: 3.40 ($340 per contract)
Days to Expiration: 25

This trade has a neutral/bullish bias on the oil producers with a fair amount of downside protection as well. As long as XOP is trading above $45,60 at expiration, the trade will be profitable.  It is essentially the same as being short the $47 put. However, by constructing the trade this way, the premium collected is significantly higher. This will allow the trade to be exited well before expiration. The plan is to exit the trade once 25% of the potential profit is realized. The trade is constructed by selling an at-the-money straddle and buying a call. Even after purchasing the 52 call option, the premium collected is still greater than the width between the short and long call, therefore there is no risk to the upside. Below is the risk profile.

Analyze_XOP_052715

/CL Futures Options

Exactly one week ago on May 20th, I sold a /CL Aug 78 call option for 0.08 ($80 credit received) with the anticipation that oil prices would decline in the short-term. That decline has occurred and today I added the put side to the position by selling the Aug 40 put option for 0.07 ($70 credit received). I now have a strangle established that has a neutral bias.

Tomorrow the EIA will report on the status of crude oil inventories which are expected to continue their decline. In the short-term this may result in a slight spike in prices. However, there is still a glut of oil and I don’t think that prices are likely to go too much higher. If oil continues to decline, airline stocks like SKYW will be the beneficiaries. If, however, oil begins climbing higher, the oil producers will be the beneficiary and XOP will rally. Oil and airlines are closely correlated. I think that this series of trades is well-balanced and will be profitable as long as oil prices don’t get extremely volatile.