Spirit Airlines: Trading Strategies While Waiting For The Airline Merger (NYSE:SAVE)

The proposed merger between Spirit Airlines (NYSE:SAVE) and JetBlue Airways (JBLU) has been in the news for months, with the Department of Justice (DOJ) challenging the deal on antitrust grounds. The DOJ argues that the merger would lead to increased prices and reduced competition in the airline industry.

In my opinion (expanded upon here) SAVE is undervalued at around $15.88. The merger court case introduces a lot of uncertainty. Yet, the upside potential for SAVE shareholders is significant as the potential return is nearly 2x your money. The flip side is that the deal failing will likely result in a 50%-80% loss. Usually, in merger arbitrage, the downside far exceeds the potential gain. The return profile is a lot like junk bond investing. You hit a lot of decent singles and then suddenly you are facing big losses.

Because Spirit and Jet Blue were taken to court by the DOJ, and the agency wasn’t interested in any settlements, the merger’s fate now lies in the hands of the judge. In the prior article, I’ve laid out that I’m inclined to believe he’s not going to block this deal. The problem is that when I’m wrong, it will be pretty costly.

Over the years, I’ve come to appreciate options (especially in conjunction with special situations) because they are so versatile and can be used to get specific types of exposure. With options, timing is a big deal. By now, everyone following Spirit has pretty much placed their bets, and I think the open interests could be informative about how people are positioned. Below I’ll go over open interest and Gamma Exposure charts that give an idea of how traders are sprinkling their bets around on the roulette table.

It doesn’t really matter for the purposes of this article, but Gamma exposure is a measure of the sensitivity of an option’s delta to changes in the underlying asset’s price. Then Delta indicates the option’s price movement relative to the underlying asset’s price. Gamma is calculated as the change in delta divided by the change in the underlying asset’s price.

Gamma is concentrated between $20 and $25:

Call buying appears most popular (which makes sense given the anticipated event). I suspect traders have also been selling very long-dated puts. That also makes some sense in the event the merger closes, and you get all that premium while no risk remains.

Rumor has it that Judge William Young won’t deliver his ruling in 2023. Instead, he targeted the new year. I don’t know about you, but I got a lot less done in the last 2/3 weeks than I expected and I didn’t expect much. Could we be a flu away from the decision getting pushed into February? It won’t matter hugely to the parties as the deal agreement expires at the end of Jan but automatically extends.

At least two options trades appear attractive to me as I’m writing this. A lot of traders appear very interested in the Jan 19 2024 expiration. That’s where I think a lot of traders have calls expiring. The interest is concentrated in the $20 to $25 strike range. It is currently trading well below that range. I think it could be interesting to consider a call spread. For example, the $15 19 January 2024 call costs $3.85, and it is possible to sell the $20 19 January 2024 call against it for $1.71. For $2.14 the potential upside is $5. Well over 100%, although it needs to appreciate at least 9% or the option will expire worthless. In the last month, SAVE traded up 11.91%.

This option idea will almost certainly work if a favorable decision is issued before the expiration date. It may also work (to a much lesser extent) without a favorable decision coming out. I expect the bullish positioning by traders at the higher strikes could help the stock to move in that direction. Negative news or no news and the option could easily zero out and there are only 11 days left to expiry.

That gets me to my second idea. That’s to sell the January 19, 2024, $25 call for $0.48, and buy the February 16, 2024, $25 call for $1.10. If the decision comes before January 19, the positions should largely offset each other. If the decision doesn’t come before January 19, it may be a little bit uncomfortable if the stock trends in the direction of the $25 strike. The January strike may not lose time value as fast as options usually do, it will remain relatively bid because an event is expected any day. On expiration, they will lose their value (if no decision and the share price is still below $25) and at that point, this position consists only of a February 15 $25 call acquired for $0.62. The position could net $4.38.

Most likely, this idea won’t work. I wouldn’t be surprised if a ruling comes out this week or next. There is also a small chance this position will work if the decision comes out and it is favorable but the spread to the merger closing remains relatively wide (i.e. the stock somehow trades below $25 until the January option expires).

The impending decision on the Spirit Airlines and JetBlue Airways merger has turned into quite a thrilling affair. While the potential for significant returns exists the downside risk is large. A judge ruling is going to decide the fate of this event. Option positioning seems to indicate most traders are positioned in the main expiry of January and likely own calls at the $20 and $25 strike. This leads me to believe positioning adjacent (but different) to these strikes could be advantageous. It also seems possible to me that the decision is pushed into February while most traders are still positioned on the 19th of January. Probably they are right but it seems cheap to own the off chance they’re wrong.