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Delta Air Lines (NYSE: DAL) appeared on my bearish scan Friday night, which alerted me to a possible bearish bet toward the stock.
Delta had been in a downward sloped trend channel going back to the December-January time frame, but the rally last week took the stock above the upper rail of the channel.
However, the slow stochastic readings just made a bearish crossover, and in the last six months those crossovers have been very good signals for a drop in the 10% range. It is also worth noting that the 10-day relative strength index (RSI) hit an overbought level for the first time since December.
Looking at the weekly chart, we can see the downward tendency displayed so far this year. We also see the most recent low down at the $41 level.
One of the things that has been weighing on Delta and other airline stocks is the price of oil. After dropping from June through January and seeing the price drop over 60%, oil has finally started to creep higher. If oil continues to move higher, the airline stocks will most likely continue to struggle.
Turning our attention to the sentiment indicators, I want to look at the sentiment toward Delta, as well as the sentiment toward oil. The sentiment toward Delta is extremely bullish, with a short interest ratio of only 1.5 and 17 of the 19 analysts following the stock rate it as a “buy.” As a contrarian, those are the types of sentiment readings that make me pay attention.
As far as the sentiment toward oil, the Commitments of Traders report for oil has turned more bullish in the last four weeks, but it has a long way to go before the bullish sentiment reaches the level it was at last summer before the drop in oil prices. In fact, large speculators were the least bullish they have been in two years just a month ago.
Between the chart pattern, the extreme bullish sentiment toward Delta and the low bullish sentiment toward oil, the probability of a decline in Delta stock looks much more likely.
I would look to buy Delta Air Lines put options in order to profit from a decline. Looking at the pattern on the daily chart, it will likely take at least 10 trading days for the drop to reach its full potential, so there are a couple of ways to play it.
If you want to be more aggressive, you can play the regular monthly May put options that will expire on May 15. Or if you want to use a more conservative approach, you can use the June options that will expire on June 19.
Either way, I like the 48 strike put options, as they are $1 in the money and they have a nice risk-reward ratio. If the stock drops 10% from the $47 area, that would take the price down to $42.30, and the $48 strike puts would be $5.70 in the money. The May 48 strike puts are priced at $2.04 presently, and the June 48 strike puts are priced at $2.99.
So if the price drops 10% before May 15, the May 48 strike put should jump close to 180% in price. The June 48 strike put would jump approximately 90%. Both scenarios give you high potential rewards; it is just a matter of how aggressive you want to be.
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