Unusual Options Activity Points to Turbulence for Southwest Airlines (LUV)

Easily the unwitting poster child of the COVID-19 crisis was the broader travel industry. First came the stranded cruise ships and eventually, empty airports. Slowly and painfully, though, sector players like Southwest Airlines (LUV) gathered up the broken pieces and began the recovery process. Unfortunately, Mother Nature had other ideas for LUV stock.

A few days before Christmas weekend, forecasters predicted “an onslaught of heavy snow, ice, flooding and even tornadoes,” according to the Associated Press. Impacted regions included the Plains, Midwest and the East Coast. Further, experts projected that the holiday weekend would be the coldest in decades. And while jokes abound about the accuracy of weather forecasts, for LUV stock, the predictions came a little too close to home.

By Friday afternoon, the issue became an ominous one. Another AP report mentioned that “more than 4,800 flights into or out of U.S. airports had been canceled, according to the flight tracking service FlightAware.” While this weather-related headwind hurt all airliners, LUV stock suffered the brunt of the damage.

After the U.S. market opened on Tuesday, LUV stock eventually closed down nearly 6%, far worse than other sector players. In particular, CNN pointed out that the winter storm devastated Chicago and Denver, where Southwest has two of its biggest hubs.

However, the news agency also pointed the finger at Southwest’s aggressive schedule and underinvesting in its operations. When the so-called tripledemic surged – leaving people (including of course airport and airliner staff) sick with COVID-19, the flu and RSV (respiratory syncytial virus) – Southwest found itself unprepared.

With investors in no mood for sticking their necks out regarding risky enterprises, LUV stock came under the crosshairs of options traders.

LUV Stock Attracts (Unwanted) Unusual Options Activity

Following the close of the Dec. 27 session, LUV stock represented one of the highlights in Barchart.com’s screener for unusual stock options volume. This metric shows the difference between the current volume and the average volume over the past month. Traders often times advantage this information to determine which securities may be due for big moves ahead.

Specifically, LUV’s volume level reached 108,943 contracts against an open interest reading of 258,379. Call volume hit 22,626 contracts versus put volume of 86,317. Further, the delta between the trailing-month average total volume versus the Tuesday session volume came out to 435.27%. The implied volatility (IV) rank hit 3.20%, which indicates the (at the money) average IV relative to the highest and lowest values over the trailing one-year period.

To summarize, IV signifies the expected volatility of a stock over the life of an option. As certain influencing factors for the underlying investment changes, the IV will likely change as well. Further, as demand for an option increases, so too will its IV.

The IV low for LUV stock was 30.25% on Dec. 21, 2022. Several months earlier on May 12, LUV hit its IV high at 342.55%. Prospective investors should note that per Barchart.com’s technical analysis gauge, LUV ranks as an average 56% sell. LUV’s medium and long-term indicators rate bearishly, while its short-term indicator points to a sentiment of “hold.”

Nevertheless, at time of writing, most covering analysts maintain an optimistic view regarding LUV stock. However, this consensus opinion has shown a small crack developing. Three months ago, Wall Street experts rated Southwest as a “strong buy,” breaking down as 11 strong buys and four holds. In the current month, LUV is a consensus “moderate buy” – 11 strong buys and five holds.

Presently, LUV stock features a 60-month beta of 1.07, which is slightly more volatile than the benchmark equities index. However, Southwest is scheduled to release its next earnings report on Jan. 26, 2023. With all that has transpired over the holiday weekend, LUV could be unusually unpredictable heading into the disclosure.

Macro Headwinds May Pose Challenges

To be sure, one of the contrarian angles that daring investors will explore regarding LUV stock is robust travel sentiment. Earlier this year, many analysts warned that the sharp rise in energy costs and skyrocketing inflation could deter would-be travelers. So far, though, revenge travel appears to remain intact.

Still, this circumstance might not last indefinitely. As I mentioned several months ago in May, American consumers started to rack up massive debt. Sure enough, credit card balances reached an all-time recorded high recently per the Board of Governors of the Federal Reserve System. Fundamentally, people can no longer ignore this vulnerable condition, which may negatively affect travel sentiment.

Additionally, layoffs – particularly among high-paying technology positions – will surely stress the broader consumer economy. Essentially, if this condition exacerbates, fewer people will have high-paying jobs, thus crimping discretionary expenditures. Therefore, investors may want to wait for better signals before booking a flight with LUV stock.

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