Are airlines good investments right now?
The COVID-19 pandemic was in many ways a true “black swan” for many stock market sectors. The spate of ensuing lockdowns and government regulations tested the resiliency of many industries. In particular, the airlines industry was particularly hard-hit, as global travel grinded to a standstill amid strict quarantine and entry requirements imposed by many countries.
More than two years later, the airline industry has staged a rocky, tentative recovery. Year-to-date, the US Global Jets ETF (JETS) is still down over 10%. Skyrocketing commodities prices have depressed the margins of airline operators, forcing them to cut costs elsewhere or raise ticket prices to compensate. Consumer have been slow to return to pre-pandemic travel habits as soaring inflation and rising rates curbed household spending. Fears of an impending recession have also promoted many to tighten their budgets in anticipation.
Spotting market inefficiencies in the airlines industry
Still, the current high volatility (and arguably bear) market offers attentive investors some potent trading opportunities. Earlier on March 23rd, Leverage Shares Director Oktay Kavrak tweeted about the possibility of setting up a pairs trade using Boeing (BA) and Airbus (AIR).
Pair trades are a type of arbitrage involving involve long and short positions in two different stocks with a positive correlation. To initiate a pairs trade, a trader must first identify two historically correlated stocks that have recently diverged in performance.
Once this has been identified, the trader takes a long position in the underperforming stock and sells short the outperforming stock. Profiting from a pairs trade relies on both stocks converging on their historical correlation, as the underperforming stock appreciates, and the outperforming stock falls.
Below I’ve plotted a chart of Boeing and Airbus stock’s YTD performance. We see that around April 25th, both stocks diverged significantly, with Boeing underperforming and Airbus outperforming.
As of writing, Boeing and Airbus have a negative correlation of -0.39 based on YTD data. Historically, the correlation between both stocks has been significantly higher, at around 0.80 based over a trailing 10-year period from 2012 to present.
Instruments to use
Investors looking to set up a pairs trade should therefore go long in Boeing and short in Airbus. For the former, buying the ticket should be sufficient. However, gaining short exposure for the latter is a bit more complicated.
Shorting a stock requires the use of portfolio margin. This is risky as margin is subject to borrow rates (which are expected to go up as various central banks initiate interest rate hikes) and the ever-present danger of a margin call should the value of the shorted security suddenly skyrocket.
Investors can also go short via put options. However, this exposes an investor’s capital to theta decay (the rate at which an options premium loses value over time), and implied volatility (IV) crush (the loss in an options premium due to suddenly decreased volatility, typically after earning are released). Options also expire, so a degree of market timing is required which causes additional risk.
A better way of gaining short (or long exposure) is by using Leverage Share’s suite of exchange-traded products, which offer the potential for a higher risk/reward profile via built-in daily three times (3x) resetting leverage.
A hypothetical investor looking to initiate a pairs trade can therefore go long on Boeing with 3x leverage by buying BA3, while going short on Airbus with 3x leverage by buying AIRS.
The final word
The physically backed nature of both ETPs ensures good liquidity and a narrow bid-ask spread, allowing you to enter and exit positions easily. Your risk is also capped based on how many shares you hold, making position sizing easy (just buy and sell shares) compared to maintaining margin requirements or calculating options delta exposure.
Sandeep joined Leverage Shares in September 2020. He leads research on existing and new product lines, asset classes, and strategies, with special emphasis on analysis of recent events and developments.
Sandeep has longstanding experience with financial markets. Starting with a Chicago-based hedge fund as a financial engineer, his career has spanned a variety of domains and organizations over a course of 8 years – from Barclays Capital’s Prime Services Division to (most recently) Nasdaq’s Index Research Team.
Sandeep holds an M.S. in Finance as well as an MBA from Illinois Institute of Technology Chicago.
Violeta joined Leverage Shares in September 2022. She is responsible for conducting technical analysis, macro and equity research, providing valuable insights to help shape investment strategies for clients.
Prior to joining LS, Violeta worked at several high-profile investment firms in Australia, such as Tollhurst and Morgans Financial where she spent the past 12 years of her career.
Violeta is a certified market technician from the Australian Technical Analysts Association and holds a Post Graduate Diploma of Applied Finance and Investment from Kaplan Professional (FINSIA), Australia, where she was a lecturer for a number of years.
Julian joined Leverage Shares in 2018 as part of the company’s premier expansion in Eastern Europe. He is responsible for web content and raising brand awareness.
Julian has been academically involved with economics, psychology, sociology, European politics & linguistics. He has experience in business development and marketing through business ventures of his own.
For Julian, Leverage Shares is an innovator in the field of finance & fintech, and he always looks forward with excitement to share the next big news with investors in the UK & Europe.
Oktay joined Leverage Shares in late 2019. He is responsible for driving business growth by maintaining key relationships and developing sales activity across English-speaking markets.
He joined LS from UniCredit, where he was a corporate relationship manager for multinationals. His previous experience is in corporate finance and fund administration at firms like IBM Bulgaria and DeGiro / FundShare.
Oktay holds a BA in Finance & Accounting and a post-graduate certificate in Entrepreneurship from Babson College. He is also a CFA charterholder.
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