Airlines Benefit From the News on Oil
Oil prices fell after Saudi Arabia and Russia seemed to reach an agreement to increase production. According to Arabian Business,
“OPEC and its allies are likely to gradually revive oil output in the second half of the year to ease consumer anxiety as prices trade near $80 a barrel”, said Saudi Energy Minister Khalid Al-Falih.
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The Saudi comments, echoed by Russia, mark a major shift in the historic alliance they forged in 2016 to end a global oil glut. While the producers were determined just a month ago to keep supply restrained and boost prices, they’re now changing course as oil’s surge to a three-year high puts strain on the global economy and draws political heat from major consumers, notably the US.
“I think in the near future there will be time to release supply” smoothly to avoid shocking the market, Al-Falih said at the St Petersburg International Economic Forum in Russia. When OPEC, Russia and other major producers meet in June “we will do what is necessary” to reassure consumers, the minister said.
He spoke after talks with his Russian counterpart Alexander Novak, who said the output increase would start in the third quarter, if it’s approved by other members of the group. Both men said the size of the boost was still subject to negotiation.”
Oil quickly fell on the news.
Airlines Benefit From Lower Oil Prices
Higher oil prices had beaten down the shares of companies that have significant exposure to the commodity. Among the industries that are the most exposed is the airline industry. American Airlines (Nasdaq: AAL) was one of the stocks that sold off as oil rallied.
News of cheaper oil led to a rally in the stock, pushing the price to the high end of short term resistance. The stock however faces an uphill struggle as the company is likely to see slower relief from the prices, since companies typically lock in prices ahead of time to ensure adequate supply.
The stock is now likely to settle into a trading range bounded by the support and resistance levels that have formed over the past few weeks. Traders are now likely to await news before significantly increasing or decreasing their exposure to the stock.
A Strategy to Benefit From a Calm Market Environment
For American Airlines, there is a relatively high likelihood of a relatively narrow trading range. One options strategy that benefits from a stock in a trading range is an iron condor. This strategy has the added benefit of carrying limited risk.
To open an iron condor trade, the investor sells one call while buying another call with a higher exercise price and sells one put while buying another put with a lower exercise price. Typically, the exercise prices of the calls are above the market price of the stock and the exercise prices of the put options are below the current price of the underlying stock.
In an iron condor, the difference between the exercise prices of the two call options will be equal to the difference between the exercise prices of the two put options. The final requirement for this strategy is that all of the options must have the same expiration date.
The risks and potential rewards of the strategy are shown in the following diagram.
Source: The Options Industry Council
The maximum gain on this trade is equal to the premiums received when the position is open. The maximum risk is equal to the difference in the two exercise prices less the amount of the premium received when the trade was opened.
Opening an Iron Condor in American Airlines
For American Airlines, the trade can be opened using the following four options contracts:
As you see, all of the options expire on the same day, Friday, June 15.
The difference in the exercise prices of the calls or puts is equal to $1.00. Since each contract covers 100 shares of stock, this means the maximum risk on the trade is equal to $100 less the premium received when the trade was opened.
Selling the options will generate $1.10 in income ($0.70 from the call and $0.40 from the put). Buying the options will cost $0.80 ($0.50 for the call and $0.30 for the put). This means opening the trade will result in a credit of $0.40, or $40 for each contract since each contract covers 100 shares.
The maximum risk on the trade is equal to the difference in strike prices ($1.00) minus the premium received ($0.40). This is equal to $0.60, or $60 since each contract covers 100 shares. Many brokers will require a margin deposit equal to the amount of risk. That means this trade may require just $60 in capital.
The maximum gain on the trade is the amount of premium received when the trade is opened. In this case, that is $0.40 or $40 per contract.
The potential reward on the trade ($40) is about 67% of the amount risked, a high potential return on investment for a trade that will be open for about three weeks. If a trade like this is entered every month, a small trader could quickly increase the amount of capital in their trading account.
This trade could also be closed out early to reduce the potential risks of the trade. It could still deliver its maximum gain even if the position is closed before the expiration date of the options.
The iron condor is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that should be lower than owning the stock.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.