Tim Bovee, Private Trader: AAL: A longer-term play

Update 2/9/2015: I've closed my position in AAL and calculated combined results for the shares and the hedges.

The shares gained 15.3% over the 264-day lifespan of the position, or a +21% annual rate. The shares and option hedges that made up my positions together produced a +11.1% yield on debit, for a +160% annual rate.

Update 11/3/2014: I've closed my bearish hedge after the price of the underlying stock closed the month above its 12-month moving average. As is my practice, I'll put off calculating profit and loss until after the entire position is unwound.
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Update 7/9/2014: I've opened a bearish hedge on AAL after the price closed below its 55-day price channel. With implied volatility standing at a relatively high level compared to its recent history, I've structure the hedge as a bear call spread, sold for credit, short the $34 calls and long the $35 calls, and expiring Nov. 21. I'll keep rolling the position forward in whatever form makes sense at the time until hedging conditions no longer obtain.

Update 8/15/2014: I've exited my bearish hedge on AAL as the price traded above its stop/loss level and confirmed the signal the next day. As is my practice with position series, I won't calculate profit and loss until the series is complete.

I complied with the signal under strict construction of my trading rules. However, the chart suggests that the downtrend continues, marking the present rise is a head fake in the making.

This isn't the first time I've seen chart truth run contrary to requirements under my longer-term trading rules. I'm considering the issue and may decide to change the rules.

The chart below shows in detail a continuation of the decline from June 23, framed according to the rules of Elliott wave analysis. My use of the base degree in the count is somewhat arbitrary; the actual degree may well be somewhat lower.

Click on chart to enlarge.

AAL 30 days hourly bars

Update 8/6/2014: AAL closed below its 20-day price channel on Aug. 5 and confirmed the signal by trading below that level the next day. I've opened a bearish hedge under my longer-term trading rules, structuring it as as a bear call spread expiring Sept. 19, short the $38 calls and long the $39 calls, sold for a credit and expiring Sept. 19. The leverage is 5:1.

The chart suggests that if wave 5 {+3} was indeed completed at $44.88 on June 23, a correction has begun that will eventually take back part of the rise that began from $3.96 on Nov. 23, 2011.

An alternate view sees the decline from late June as an internal correction with an ongoing wave 5 {+1}.

Click on chart to enlarge.

AAL 11 months daily bars

If a major decline has indeed begun, it will mark the first major test of my longer-term rule set, posing the question, How to handle a larger-degree correction within the hold-and-hedge strategy I've adopted.

Update 5/30/2014: AAL resumed its upward momentum and I've opened a bull position, structured as long shares under my longer-term rules, intending to hold the position through May 30, 2015.

Update 5/27/2014: AAL failed to show upside momentum in the half hour before the closing bell and indeed has dropped below its prior high. I've moved it to the Watchlist and will consider it upon a break above today's new high, $39.93.

American Airlines Group Inc. (AAL) is recovering bankruptcy and has moved up to a new high. The charts are bullish. But what do you with a stock that has no fundamental record to go on and that is, in fact, an occasion for an act of faith. As a rational trader, I take the risk, at least as long as I can hedge my bet.

The Company

American Airlines, headquartered in Fort Worth, Texas, is recovering from the Chapter 11 bankruptcy it filed in 2011, through cost-cutting, including layoffs, rebranding and a merger proposal accepted last year with US Airways Group.

Any long-term position in AAL is a bet on a corporate comeback. The company isn't profitable. Earnings per share for the past year are negative $6.30.

Any interest in AAL relies on hope for the future.

Analysts in aggregate are a hopeful bunch, collectively coming down with a positive 27% enthusiasm rating.

Certainly, low prices alone might well justify enthusiasm for AAL. They fly more than 600 plans to about 160 destinations on four continents. That ought to be worth something.

Earnings and growth estimates imply a "fair" price of $155.57 per shares, suggesting that AA is underpriced by 75%.

The company pays no dividend.

Losing companies, or companies emerging from loss, really don't give me much to go on when it comes to the fundamentals. I can't calculate a return on equity. Debt is running 14 times equity, a crushing load.

Institutional ownership is on the low side, at 56% of shares.

And yet Zacks Investment Research, the service I rely on to give me a shortcut in assessing the fundamentals, gives American Airlines its most bullish rating.

My take away is that AAL is a risky play, but there's nothing about longer-term positions that need exclude risk.

The Chart

AAL came to my attention because today it broke above its high of March 10, $39.88. That suggests that the stock is resuming its upward course after a brief correction

Elliott wave analysis suggests that AAL is completing an A wave correction to the upside that began in July 2008, at the Great Recession low. From that level down, every degree is in its 5th and final wave.

Click on chart to enlarge.

AAL 20 years monthly bars (left), 3 years 3-day bars (right)

However, AAL in emerging from bankruptcy may not be the stock it was. It began trading under a new symbol on Dec. 9, 2013, migrating from a symbol that traded on the Pink Slips.

Although my charts merge together the pre-bankruptcy, in-bankrutpcy and new charts, I think it's at least arguable that the day AAL began trading marks a new record, a new chart, representing a new series of counts using Elliott wave analysis.

If that's the case, then AAL is still beginning a 5th wave, but I know longer know the degree. On the chart below I've used the base degree, but it could be something lower, with much upside potential.

Or not.

Click on chart to enlarge.

AAL since Dec. 9, 2013, 180 days 2-hour bars

Liquidity and Volatility

AAL on average trades 7.8 million shares a day and supports a wide selection of option strike prices spaced a dollar apart. The front-month at-the-money bid/ask spread on puts is 9.1%, compared to 0.3% for the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

For a longer-term position, this means that the options are liquid enough that I can use them for hedging in the event of a downturn.

Implied volatility stands at 33%, compared to 12% for the S&P 500 index. Options are pricing in confidence that 68.2% of trades will fall between $26.57 and $53.29 over the next year, for a potential gain or loss of 33.5%.

Why longer term?

I think AAL will recover, but I can't say how quickly. A longer-term position in shares gives me the luxury of waiting out any bad times, and perhaps even profiting from hedges, and then regaining my paper losses and more when the upward move resumes. In addition, of course, I get a lower tax rate on capital gains from positions held for more than a year.

Options positions don't really give me that luxury. They need to be rolled over every few months, and that generates a lot of transaction costs.

Decision for My Account

I intend to open a bull position in AAL under my longer-term rules. I'll open it today if the price shows momentum to the upside. Otherwise, I'll wait for an opportunity.

-- Tim Bovee, Portland, Oregon, May 27, 2014

References

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.