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COMMENTARY Fri Jul 18, 2008: Missed the Bottom in Airline Stocks? With the correction in crude oil prices from the mid-$140's per barrel down below $130 this week, airline stocks rallied sharply on hopes of reduced fuel costs. Is it too late to jump in and buy them now? American Airlines (NYSE-AMR) rallied from a low of $4 per share on Tuesday to $7.13 by Friday's close. On a longer-term basis, the stock is still far from its one-year high of almost $30. Instead of just buying the stock, we could sell puts. The August 7.00 puts are currently trading at $90 each per 100 shares of stock. This would give us an income of about 14% for one month assuming the stock stays above $7 by expiration day Friday August 15th. If the stock is below $7 the put option will expire in-the-money, and the option buyer can exercise their right to sell ("put") 100 shares of AMR stock to us. We would be assigned a buy order at $7 per share. Our net cost would be $6.10 per share because we received 90 cents per share for the puts. Selling put options is an attractive strategy for investors who want a slight edge, in terms of percentage income and probability of success, over the approach of simply buying the stock. If the stock continues sharply higher they can miss out on bigger gains. But in a risky market any advantage is worth considering, no matter how small. In fact, the income from put option writing can be substantial. As you can see from the table below, even further out-of-the-money put options on AMR stock currently offer attractive income potential. Until next time, best of luck with your option investments!
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| Note: Cash-covered put yields assume that the required net amount to purchase the stock is deposited prior to writing a naked put. If the put is assigned the stock would be purchased at a net cost of the strike price minus the premium received. The yield is calculated by dividing the income by the net cost. The income is the premium received for out-of-the money puts, or the amount above and beyond the in-the-money amount for in-the-money puts. With cash-covered put writes, the goal is to either pocket the premium if the option expires worthless, or if assigned on the put option to buy the stock at the strike price which is a discount to the current price. If the stock goes down below your purchase price by more than the option income received, you have a loss. | |
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