With the geopolitical situation in Iran and other regions weighing heavily on markets, investors may not have much confidence in the equities sector. However, former industrial conglomerate turned aerospace specialist GE Aerospace (NYSE: GE) looks to be one of the premier names for concerned traders. From both a fundamental and technical perspective, GE stock appears to have the right stuff.
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No longer an everything-for-everyone type of enterprise, GE is essentially a pure-play aerospace propulsion and services business. That right there is a massive advantage as the underlying industry has unusually strong long-duration economics. Essentially, GE stock is an investment in a recurring cash-flow machine.
Critically, what keeps the lights on at the company is not just engine sales. Rather, GE is involved in maintenance, repair, overhaul, replacement parts and long-term service agreements. It’s a beautiful arrangement for stakeholders of GE stock. Once an airline buys GE-branded engines, it partially locks itself into the company’s ecosystem for decades. That creates recurring, high-margin aftermarket revenue, leading to impressive financial results.
For example, in last month’s first-quarter disclosure, GE posted earnings per share of $1.86 on revenue of $12.39 billion, easily exceeding analysts’ consensus targets of $1.61 and $10.67 billion, respectively. In the year-ago quarter, EPS landed at $1.49 on revenue of $9.94 billion. These figures aren’t fluky either, with GE stock benefiting from consistent beats on both the top and bottom lines.
Moreover, investors have reasonable expectations that, as the years progress, the bullish case for GE Aero will be even more convincing. Primarily, the company builds engines for the Boeing (NYSE: BA) 737 MAX family and the Airbus (OTCMKTS: EADSY) line. These aircraft represent the most important narrow-body aircraft programs globally, providing tremendous growth potential.
Beyond the expected scale, engine economics should improve favorably for GE stock as fleets age into heavier maintenance cycles. Yes, the security does carry a relatively high premium. Arguably, though, it’s not unjustified given the recurring business trends.
Volatility Skew Signals Some Hesitation Toward GE Stock
With the compelling narratives supporting GE stock, it may seem a bit odd that shares are down roughly 9% on a year-to-date basis. Much of that, of course, is related to the current Iran conflict. With global supply chains at risk, energy prices have been soaring. By logical deduction, that’s not great for the aerospace industry as airlines start scaling back their operations.
However, GE stock does enjoy some mitigating elements to soften the impact of this headwind. From GE’s perspective, the risk comes in the form of flight-hour exposure, since the company’s aftermarket economics depend heavily on planes flying enough hours to catalyze engine wear and maintenance intervals.
Still, the nuance here is that older aircraft may stay in service longer, which forces greater attention on maintenance intensity, overhaul demand and spare parts consumption. Plus, airlines were already having trouble replacing aging fleets, which translates to sustained maintenance business for GE.
If that wasn’t enough, GE does have a defense unit, which facilitates perhaps a cynical benefit amid all the violence. So, GE stock isn’t exactly naked and exposed to a bearish storm — yet the smart money doesn’t seem all that convinced.
If you look at the volatility skew for the July 17 expiration date, you’ll notice that in the options market for GE stock, the net posture is slightly aligned toward downside risk protection. To be clear, the implied volatility (IV) for both calls and puts is relatively flat and linear for strikes near the spot price. Basically, smart money traders don’t anticipate GE shares to rock the boat violently in either direction near the at-the-money (ATM) price.
Instead, the purchasing of insurance is at the tails and predominantly at the left-hand tail. As the strike price zone pivots lower and away from the ATM price, put IV starts rising above call IV. In other words, sophisticated players are willing to pay a premium for extreme downside protection. On the right tail, put IV is also dominant relative to call IV, suggesting a protective posture.
It’s worth pointing out that the smart money isn’t necessarily prescient but rather transactionally sophisticated. Still, with skepticism apparently baked into GE stock, there may be a chance for a contrarian opportunity.
Triangulating a Trade
One of the key tactical advantages of being a GE stock bull is that the security enjoys an upward bias. Using a dataset from January 2019, a random long position held for 10 weeks is likely to generate an exceedance ratio of 61.9%. That means if you were to buy GE simultaneously across a hundred parallel universes, you’d likely be profitable 62 times.
Nominally, the expected forward 10-week distribution would likely place GE stock between $275 and $304. However, the most likely median outcome will probably be somewhere between $285 and $293. Don’t expect to get rich trading GE randomly.
Of course, we’re not interested in rolling the dice for the sake of it. Instead, we’re interested in trading GE stock under specific conditions. In the last 10 weeks, GE printed only three up weeks, leading to an overall downward slope. Under this 3-7-D sequence, the overall exceedance ratio doesn’t really change much.
Still, an interesting point is that the forward distribution benefits from a net positive push in the right direction. Over the next 10 weeks, we would expect GE stock to land between $270 and $320. A major wrinkle is that on July 16, the company will release its Q2 report.
If you’re feeling extra bullish, I’d look into the 300/310 bull call spread expiring July 17. Yes, GE stock would need to rise through the $310 strike at expiration for the trade to be fully profitable. However, this strike falls within the expected 10-week distribution under 3-7-D conditions. Also, a positive earnings report could provide an extra boost.
Should the stars align, you’re looking at a maximum payout of roughly 167%. If you have some spare change for an options wager, GE stock is arguably worth consideration.
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