American Airlines Stock Has Large Unusual Options Activity - It Could Be Cheap Here

American Airlines (AAL) stock showed large, unusual trading volume in one-month expiration put options on Tuesday's close. That could be a buy signal for value investors. It also gives short-put traders a 3.6% yield over the next month.

AAL closed at $10.99 on Tuesday, Sept. 10, down from a recent peak of $11.22 on Monday. It's also up almost 19% from a low of $9.26 on Aug. 7.

But some traders are now buying (and short sellers are selling to them) large volumes of put contracts that expire in the next month. The Barchart Unusual Stock Options Activity Report shows that over 26,700 put option contracts traded yesterday at the $10.50 strike price for expiry on Oct. 11, 31 days away.

AAL puts expiring Oct. 11 - Barchart Unusual Stock Options Activity Report as of Sept. 10

This strike price is 49 cents below the $10.99 spot price, so it is deemed “out-of-the-money” (OTM) by 4.5% (i.e., $0.49/10.99). In other words, the put buyers hope that AAL stock will decline to below $10.59 (i.e., $10.99-$0.40 ask price), or 3.63% before their investment will have any intrinsic value.

They also might be willing to flip their put option purchases if AAL stock quickly falls to $10.60 or so in the next two weeks and the put option price rises. That might be the case if AAL stock keeps dropping, even though there is no intrinsic value in the underlying put option.

Short Put Yield Is High

But the short sellers of these put options already are making money. They get to receive $38 for every $1,050 in cash and/or margin they secure with their brokerage firm per put contract they short. In other words, shorting 100 contracts costs $105,000 (i.e., 100 x $10.99 x 100 shs/contract), but the short put investor receives $3,800.

Therefore, the immediate short-put yield is 3.62% (i.e., $0.38/$10.50). Moreover, the investor's breakeven point is lower at $10.12 (i.e., $10.50-$0.38). So, AAL stock would have to drop 7.9% or so in the next month before these investors lose money. They would be forced to buy stock at $10.50, but their cost is only $10.12 after the income received.

That requires essentially a bullish investment position towards AAL stock. Let's look at why that might be warranted.

American Airlines Free Cash Flow Remains Strong

Analysts are very bullish on AAL stock. The average sell-side analyst has a price target of $12.46, according to Barchart, and $11.58 based on Yahoo! Finance's survey of 15 analysts. Moreover, AnaChart, a new sell-side analyst tracking site, reports that 15 analysts have an average $14.48 price target. That is over 31% higher than Tuesday's close.

And why not? AAL stock is cheap at just 10.6x forecast earnings per share (EPS) of $1.04 this year. Moreover, analysts project $1.89 EPS for 2025, giving AAL a forward multiple of just 5.8x.

In addition, American Airlines is generating large amounts of free cash flow (FCF). In the first half of 2022, it made $2.217 billion in adj. FCF, representing 8.2% of its $26.9 billion in operating revenues during the period.

So, since analysts project $56.6 billion in 2025 revenue, its FCF could hit $4.64 billion next year (i.e., 0.082 x $56.6b revenue). That could push AAL stock significantly higher. 

AAL Stock's Value

One reason is that the company still has not paid dividends since the first quarter of 2020. Let's see what AAL stock could be worth if it decided to do this.

Let's assume American Airlines decides to pay out one-third of its projected 2025 FCF as a dividend. The market would likely give the stock at least a 5.0% dividend yield. Here is how that would push AAL stock higher. 

First, one-third of $4.64 billion in est. FCF is $1.545 billion in potential 2025 dividends. So, dividing this by 5.0% would give the stock a $30.9 billion market valuation (i.e., $1.545b/0.05 = $30.9b). That is 329% higher than its existing market cap of $7.2 billion.

However, just to be very conservative, let's assume the dividend is less than half of that amount or $657 million, or $1.00 per share annually. Using a 5.0% dividend yield, the market value for AAL stock would be $20.00 per share (i.e., $1.00/0.05 = $20.00). That is still 81.9% over today's price of $10.99.

So, AAL stock is very cheap here today. This is based on its low P/E multiple, the projected free cash flow, and a dividend yield scenario. Moreover, sell-side analysts' price targets are substantially higher than today's price. 

These could be some reasons why put option short sellers are willing to sell short near-term puts to put buyers today.

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.