G’Day Bears! There’s a Smart Way to Short Embattled Spirit Airlines (SAVE)

To be completely blunt, intrepid investors don’t need much excuse to at least have the desire to short Spirit Airlines (SAVE). Obviously, the biggest concern stems from the termination of the merger agreement with JetBlue Airways (JBLU). Amid a competitive environment following a devastating disruption from the COVID-19 crisis, SAVE stock is in ugly shape.

Making matters worse, the recent data gives no impression that the discount airliner is anywhere close to making a recovery. Let’s look briefly at the company’s latest earnings results for the second quarter. On a per-share basis, Spirit incurred a loss of $1.76. When adjusted for non-recurring costs, this metric came down to $1.44 in the red. Neither result met Wall Street’s target.

On the top line, Spirit generated sales of $1.28 billion. This figure also fell below analysts' expectations, who had expected $1.31 billion. It’s no wonder that on a year-to-date basis, SAVE stock gave up almost 85% of equity value. Heaping on the misery, market experts rate shares a consensus Moderate Sell. Out of 11 ratings, seven of them were Strong Sells.

At the same time, it’s risky to directly bet against this pitiful situation. Yes, traders are betting against SAVE stock — in fact, the short interest as a percentage of float stands at 29.18%. In addition, the short interest ratio clocks in at 11.83 days to cover. However, with so much weight on the short trade, if circumstances suddenly shift to the bullish side, the bears may be caught out.

That’s why I’m not particularly gung-ho on the pure short trade. However, that’s where a controlled options strategy involving a vertical spread may come in handy.

Unusual Options Activity is Ominous for SAVE Stock

Last Friday, SAVE stock dropped about 3% of market value. Therefore, it wasn’t a shock when it represented one of the “highlights” in Barchart’s unusual stock options volume screener. What’s more, the details played out almost exactly as expected.

Total volume for the aforementioned session stood at 69,161 contracts against an open interest reading of 772,445 contracts. Overall, Friday’s volume soared 394.75% above the norm for the trailing month. Call volume reached only 6,983 contracts while put volume dominated at 62,178. Therefore, the put/call volume ratio hit an ugly 8.9.

While the above ratio is a useful tool to discern sentiment, it can also be deceptive as options involve the buying and selling of derivatives. Put another way, it matters who does the buying and selling. To better decipher market sentiment, we can turn to Barchart’s options flow, which tells us the “emotion” of the moment of institutional or professional investors.

Notably, when looking exclusively at big block transactions, net trade sentiment (which is calculated by totaling the premiums of bullish and bearish sentiment options) sat at $-136,400, favoring the pessimists. Overall, bearish options featured a premium count of $-377,500 and bullish derivatives featured a premium count of $241,100.

As expected, the smart money is betting against SAVE stock. Technically, it appears to be the right move. The equity simply cannot find stable ground. With the financials working against the company, there’s little reason to believe that Spirit can swing higher. Nevertheless, wild stuff does happen from time to time and therefore, a risk-mitigated approach may be prudent.

A Bear Call Spread Offers a Balanced Short Position

To cynically benefit from a deteriorating position in SAVE stock, an investor may consider an options strategy called a bull call spread. This is a vertical options spread that involves generating income from a sold call at a lower strike price while capping the risk (should the market move higher) by buying a call at a higher strike.

On any given day, a trader may have hundreds, if not thousands of bull call spreads to choose from, depending on their risk-reward profile. A balanced idea would be to consider the following trade for calls expiring on Oct. 25, 2024:

• Sell the $2.50 call at a bid of 36 cents.
• Buy the $4 call at an ask of 10 cents.
• The breakeven price will be $2.76.
• Maximum profit is 26 cents per contract ($26 after multiplying by 100 shares).
• Maximum loss is $1.24 per contract.
• Risk-reward ratio is 4.77 to 1 (meaning for every $1 of income earned, $4.77 is at risk).

With this position, we’re assuming that SAVE stock will not move beyond $2.76. That gives us some margin to work with. Over the next month-and-a-half period, we’re also hoping that SAVE will gradually stay at or move below $2.50 (Friday’s closing price).

That seems like a very reasonable bet; hence, the rather low reward. However, with a risk-reward ratio of 4.77, the downside risk for this short trade is also limited. It’s a more prudent way to bet against SAVE stock, especially if you’re worried about a random spike higher.