Why Southwest Airlines (LUV) Stock’s Implosion Could Offer a Contrarian Ticket Higher

On paper, the air travel sector is a mixed bag, which theoretically should have Southwest Airlines (LUV) cruising in a consolidation pattern. However, a pivotal financial decision appears to have spooked investors due to negative forward-looking implications. Subsequently, LUV stock has fallen off roughly 16% in the trailing month, leading to a 40% Sell rating from the Barchart Technical Opinion indicator.

What adds to the misfortune is that Southwest offered solid results for its second-quarter earnings, with the airliner robustly exceeding profitability targets but coming slightly short on revenue. Another positive is the overall industry. While it's obvious that the broader economy is struggling, Google Finance's summary sheet notes that Americans are flying in unprecedented numbers.

That's also evidenced by Southwest's seating and premium pivot. Rather than sticking with its traditional open-seating model, the company has introduced assigned seating and extra-legroom configurations. Analysts believe that this move could significantly exceed revenue expectations by unlocking high-margin premium traveler spending. Subsequently, there's a rational basis for optimism toward Southwest stock.

So, why the recent downturn? Primarily, Google Finance identified fuel hedging vulnerability as a key culprit. It made a strategic decision to discontinue its fuel hedging program right before crude oil and jet fuel prices surged. Naturally, this misfortune fully exposed the airline to soaring energy costs. As well, analysts then had to adjust their expectations for LUV stock.

Granted, this bit of tough luck has also expanded the competitive gap between Southwest and its rivals. But it's also fair to suggest that the bad news in Southwest Airlines stock may be priced in. With the airline industry remaining robust despite wider headwinds, speculative traders — especially options traders — may have a contrarian opportunity here.

Order Flow Imbalance Sets Up Contrarianism for LUV Stock

As a basic hypothesis, my bullish argument for Southwest stock centers on the concept of mean reversion. Right now, LUV is down more than 4% on a year-to-date basis, which without context seems rather poor. However, the extended pessimism since late June has done a number on the discount airliner. Without this unfortunate event, LUV would have been a strong performer.