Call Traders LUV This Airline Stock

06/15/2011 7:00 am EST

Focus: OPTIONS

Elizabeth Harrow

Financial Analyst, Schaeffer's Investment Research, Inc.

A stunning surge in bullish call volume is unfolding on Southwest Airlines (LUV), but expiration is fast approaching, and the stock must fly through strong resistance if these bold bets are to pay off.

Calls are in heavy rotation this week on Southwest Airlines Co. (LUV), with thousands of contracts crossing the tape each day—roughly triple the stock's expected intraday call volume during a “normal” week.

Most of the action is taking place at LUV's June 12 call, which will expire at the end of this week. This out-of-the-money strike has seen tremendous volume change hands, with roughly 93% trading at the ask price. Plus, implied volatility on the June 12 call has surged 22.9 percentage points at last look, suggesting that traders are still adding new bullish bets here.

The daily chart of LUV is quite ugly:

chart
Click to Enlarge

However, this week's preference for calls continues a recent trend for LUV. During the past ten sessions, speculators on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) have bought to open 11.5 calls for every put on the airline issue. This ratio arrives in the 68th percentile of its annual range, indicating that traders have purchased calls over puts at a faster-than-usual pace in recent weeks.

Elsewhere on Wall Street, short sellers have been cashing in on the stock's decline. Short interest on LUV fell by 12.7% during the past month, and these pessimistic positions now account for a modest 3.2% of the equity's float.

See related: Know When to Short a Stock

By buying to open the June 12 call, traders are wagering that LUV will ascend north of this strike by the end of the week. In order to accomplish this technical feat, the shares would need to tackle both their ten- and 20-day moving averages—a trend line duo that hasn't been defeated on a daily closing basis since May 20. Year to date, LUV is sitting on a steep loss of 15.8%.

That’s one optimistic bet.

By Elizabeth Harrow, contributor, Schaeffer’s Trading Floor Blog

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