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One Way To Mute Delta Share Turbulence Ahead Of Earnings: Secured Put Options

Economy
13.07.2021
186
One Way To Mute Delta Share Turbulence Ahead Of Earnings: Secured Put Options

As airlines and other travel businesses line up to release second-quarter results, investors will be paying close attention to how steep the uphill battle still is for the industry before firms see a ‘normal’ operating environment.

Among the companies being watched is Delta Air Lines (NYSE:DAL), which is expected to issue Q2 earnings before the market open on Wednesday, July 14.

While metrics announced by the Transportation Security Administration show that the number of air travellers in the U.S. is on the rise. On Sunday, July 11, the traveller throughput was 2,198,635. By comparison, a year ago (on the same day of the week), that number was 754,545. In 2019, it had been 2,669,717.

The number of air travellers is yet to reach pre-pandemic levels. Nonetheless, travel has clearly reemerged, leading to positive returns in many stocks in the industry.

Over there past year, the Dow Jones Travel & Tourism and the Dow Jones Airlines indices are up indices are up about 41.6% and 60.2%. However, year-to-date (YTD) returns have been more subdued and the two indices are up 1.6% and 14.1%, respectively.

Similarly, Delta Air Lines is up 59.8% in the past 12 months and 6.5% YTD. On March 15, DAL shares hit a 52-week high of $52.28. But before the start of the pandemic in early 2020, the stock was shy of $60.

By comparison, this is how Delta’s two main competitors have fared in the past year:

  • American Airlines (NASDAQ:AAL): up 79.2% in the past year and up 32.1% YTD;
  • United Airlines (NASDAQ:UAL): up 59.4% in the past year and up 17.1% YTD.

Prior to the release of Q1 earnings in mid-April, DAL stock was shy of $50. On Monday, July 12, it closed at $42.85. Most analysts concur in the second half of the year, airlines should benefit from increased booking and travel. Understandably, Delta bulls are hoping that the upbeat mood will soon translate into a higher share price for the company.

Therefore, today, we look at DAL stock to see how investors could consider selling cash-secured put options. Such a trade could especially appeal to those who want to receive premiums (from put selling) or to potentially own Delta Air Lines shares for less than its current market price of $42.85, at time of writing. In terms of 12-month price forecasts, the median target for the Atlanta-based airline is $55.

We previously discussed the detailed mechanics of cash-secured put selling using ExxonMobil stock. Readers who are new to put selling may want to consider reviewing that article.

Selling Cash-Secured Puts On DAL Stock

Investors who write cash-secured puts are typically bullish on a stock like Delta during the timeframe that extends to the option expiry date. They generally want one of two things. Either to:

  1. Generate income (through the premium received by selling the put); Or
  2. Own a particular stock, but find the current market price per share (i.e., $42.85 for DAL now) higher than what they’d like to pay.

One put option contract on DAL stock is the option to sell 100 shares. Cash-secured means the investor has enough money in the brokerage account to purchase the security if the stock price falls and the option is assigned.

This cash reserve must remain in the account until the option position is closed, expires or the option is assigned, which means ownership has been transferred.

Let’s assume an investor wants to buy Delta stock, but does not want to pay the full price of $42.85 per share. Instead, the investor would prefer buying the shares at a discount within the next six to 10 weeks.

One possibility is to wait for DAL stock to fall, which it might or might not do. The other possibility is to sell one contract of a cash-secured Delta put option.

As a result, the put seller would take on the obligation to potentially buy 100 shares of DAL at a certain price (the strike price) by the expiry date, and get paid a certain amount of premium now for taking on that obligation.

So the trader would typically write an at-the-money (ATM) or out-of-the-money (OTM) DAL put option and simultaneously set aside enough cash to buy 100 shares of Delta stock.

Let’s assume the trader is putting on this trade until the option expiry date of Sept.17. As the stock is currently $42.85, an OTM put option would have a strike of 41. So the seller would have to buy 100 shares of Delta at $41.00 if the option buyer were to exercise the option to assign it to the seller.

The DAL Sept. 17, 2021, 41-strike put option is currently offered at a price (or premium) of $1.77.

An option buyer would have to pay $1.77 X 100, or $177 in premium to the option seller. This premium amount belongs to the option writer (seller) no matter what happens in the future, i.e. until or on the day of expiry. This put option will stop trading on Friday, Sept. 17.

Risk/Reward Profile For Unmonitored Cash-Secured Put Selling

Assuming a trader would now enter this cash-secured put option trade at $42.85, at expiration on Sept. 17, the maximum return for the seller would be $177, excluding trading commissions and costs.

The seller’s maximum gain is this premium amount if DAL stock closes above the strike price of $41.00. Should that happen, the option expires worthless.

If the put option is in the money (meaning the market price of Delta stock is lower than the strike price of $41.00) any time before or at expiration on Sept.17, this put option can be assigned, and the seller would be obligated to buy 100 shares of DAL stock at the put option’s strike price of $41.00 (i.e., at a total of $4,100).

The break-even point for our example is the strike price ($41.00) less the option premium received ($1.77), i.e., $39.23. This is the price at which the seller would start to incur a loss.

On a final note, the calculation of the maximum loss assumes the put seller was assigned the option and purchased 100 shares of Delta at the strike price of $41.00. Then, in theory, the stock could fall to zero.

If the put seller gets assigned the option, the maximum risk is similar to that of stock ownership but partially offset by the premium (of $177) received.

Bottom Line

Cash-secured put selling is a moderately more conservative strategy than buying shares of a company outright at the current market price. This strategy can be a way to capitalize on the choppiness in Delta stock during the earnings release with a measure of prudence.

Those investors who end up owning DAL shares as a result of selling puts could further consider setting up covered calls to increase the potential returns on their shares. In other words, selling cash-secured puts could be regarded as the first step in stock ownership. Once the investor owns 100 shares of Delta Air Lines, s/he would also be able to sell covered calls and potentially enhance returns further.

Author:investing

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