Delta Air Lines has shown strong relative performance in recent weeks. DAL stock also now trades above the 21-day exponential moving average. And the long-term 200-day line, barely seen in Delta's rearview mirror, is trying to flatten out.
Meanwhile, Evercore ESI analysts recently upgraded DAL stock to outperform with a price target of 47.
Therefore, let's look at an option trading strategy known as a cash-secured put.
Why Use This Put Option?
A cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock. The goal? Either wait for the put option in DAL stock to expire worthless and keep the premium, or get assigned by the brokerage and acquire DAL stock below the current price.
Investors selling puts must know that they could get assigned 100 shares per contract for purchase at the targeted strike price.
So, a trader who sold the April 21-expiration put option in DAL stock with a 39 strike price earlier this week could have generated around $1.75 in premium per contract. On Wednesday, the premium fell to $1.50.
The put seller would have the obligation to purchase 100 shares of Delta stock at 39 if called upon to do so by the put buyer.
The break-even price for the trade? Calculate it by taking the strike price less the premium received. So, in this case we get a break-even price of 37.25. That's 4.7% below Tuesday's closing price.
If DAL stock stays above 39 at expiry, the put expires worthless, leaving the trader with a healthy 4.7% return on capital at risk. That works out to around 38% on an annualized basis.
DAL Stock Today: Risk Vs. Reward
The main risk with the trade is similar to outright stock ownership. If Delta falls precipitously, the trade will suffer a loss. However, the premium received partially offsets this loss in DAL stock.
The maximum loss on the trade would occur if DAL stock fell to $0. The overall trade would lose $3,725, but most traders would cut their losses before then.
Set a stop loss if Delta shares drop below the mid-Feb low of 36.66.
Cash-secured puts are a fantastic way to generate a nice return on stocks the trader is happy to own.
If the put does get assigned, the investor takes ownership with a reduced cost base and can potentially begin selling covered calls to generate additional income from the position.
According to IBD Stock Checkup, DAL stock ranks No. 1 in its group and has a perfect Composite Rating of 99, an EPS Rating of 82 and a Relative Strength Rating of 85.
Please remember that options are risky. Investors can lose 100% of their investment.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
