Powerful Momentum Play Could Net Traders 38% Before Year End

Jared Levy's picture

Monday, August 25, 2014 - 5:00pm

by Jared Levy

It's rare that I'll go long any stock right after it's made a series of new highs, but Southwest Airlines' (NYSE: LUV) steady bullish breakout run seems likely to continue into the end of the year.

I'm fortunate enough to live just five minutes from Southwest's corporate headquarters at Dallas Love Field. Not only can I easily catch last-minute flights, but I've also befriended numerous Southwest employees and gained an insider's perspective on the company.

Between their input and my observations and research, I see clear blue skies and tailwinds for Southwest this quarter.

There's been a long-standing law in Texas called the Wright Amendment that's limited Southwest's routes and profits over the past 35 years. The law restricts nonstop service from Love Field to airports in Texas and eight other states.

The Wright Amendment is being repealed in mid-October, and traffic at the Dallas airport is expected to increase nearly 50%. Southwest will be in a prime position to capitalize on this, but that's only part of the reason I think the stock is a buy here.

Coinciding with the Wright Amendment's full repeal, Southwest has been acquiring new planes and training its existing pilots and those from its acquisition of AirTran on the updated aircraft, new procedures and routes, all designed for maximum efficiency, comfort and profits.

In addition to new direct routes to many major cities in October, Southwest began adding popular international routes to Mexico and the Caribbean in July, and the airline is expected to add more in the near future.

This seems to be paying off, as Southwest reported traffic (revenue passenger miles) was up 6.6% in July 2014 compared to the same period in 2013.

Another reason I like LUV is that the airline exclusively flies the Boeing 737 series, with over 600 737s in service and 27 due to be delivered, giving it an advantage when it comes to the efficiency, cost and availability of repairs as opposed to having multiple types of aircraft, which is more common among its competitors.

Finally, airlines have been and always will be susceptible to fuel prices, but Southwest has proven itself to be exceptional at managing fuel hedges to keep costs stable. Fuel prices also tend to drop in the fall and winter months. Both of these factors should add to another strong quarter of earnings growth for LUV.

Even as the stock makes new 52-week highs, shares still trade at just 15.6 times forward earnings. And based on a 31.8% projected annual EPS growth rate, the PEG ratio of 0.5 makes LUV an attractive and relatively inexpensive growth play. 

LUV Call Option Trade

Today, I am interested in buying LUV Dec 29 Calls for a limit price of $3.80.

LUV Call Option

This call option has a delta of 79, which means it will move roughly $0.79 for every dollar that LUV moves, but it costs only a fraction of the price of the stock.

The trade breaks even at $32.80 ($29 strike price plus $3.80 options premium), which is 2% above current prices.

The upside target for the stock is $34.25, at which point our call option will be worth at least $5.25. Once you enter the trade, place a good 'til canceled (GTC) order to sell the call option at $5.25.

Recommended Trade Setup:

-- Buy LUV Dec 29 Calls at $3.80 or less (use limit orders)
-- Set stop-loss at $1.30
-- Place price target at $5.25 for a potential 38% gain in three months

P.S.-- Southwest Airlines' recent success has been well documented by popular market analysts, but did you know many similarly profitable stocks have been identified by a secret indicator called the Alpha Score? In the past 6 months, it's flagged 71 stocks that gained 10% or more in just 14 days. It also would have avoided the 2008 crash, beating the market by 37% that year. To get the name of its latest "buy" for free, click here.

This article originally appeared on ProfitableTrader.com: Powerful Momentum Play Could Net Traders 38% Before Year End

Jared Levy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of LUV in one or more of its “real money” portfolios.