So far, 2011has been a very rough time for stocks in the airline sector as high oil prices and a weak economy have conspired to keep prices of these securities grounded for much of the year. Yet, things were finally starting to look up for the sector in recent days, especially from a technical perspective, as the broad space bounced off of its 52 week low on Monday. However, the industry faced yet another setback before the market opened on Tuesday as the parent of legacy carrier American Airlines, AMR Corporation ( ) , sought Chapter 11 bankruptcy protection.

The company will assume a business as usual schedule for now, but many assume that job losses and a reduction in the company’s vast flight network are inevitable as the company gets deeper into the proceedings. In fact, the firm revealed in the bankruptcy filing that it has close to $5 billion more in debts than it has in assets, suggesting that a debt restructuring and a shift in pension benefit programs is likely in the near term. Unsurprisingly, this news helped to push down shares of AMR heavily in Tuesday’s session as the firm was down close to 86% in early morning trading, falling from its close at $1.62 to Tuesday’s price below $0.25 a share. This also represents a massive loss from the start of the year in which the company was trading at about $7.8 a share, demonstrating just how quickly this former titan has fallen in recent months (read The Yield King Of Leveraged ETFs).

AMR is also likely ruing its decision to not file for Chapter 11 in the years after 9/11 like its counterparts United, Continental, and Delta all did in the wake of the terrorist attacks. This decision by the other carriers, along with their preference for mergers, allowed these airlines to leapfrog American and put the firm in the precarious position it now finds itself in. “It’s painful but probably necessary,” John Strickland, an aviation analyst at JLS Consulting in London, said today in a telephone interview with Bloomberg. “They will have to go through the whole process that their peers have gone through.”

Airline ETF In Focus

For investors seeking to make a broad play on the airline sector, either long or short, Guggenheim’s Airline ETF ( ) is really the only option available at the current time. Yet, investors should note that at the beginning of trading on Tuesday, AMR made up a small part of FAA’s holdings, at just 2.6% overall. Instead, the fund allocates heavy weightings to Delta ( DAL - Analyst Report ) with just under 16%, Southwest ( LUV - Analyst Report ) at 14.7%, and United Continental Holdings ( UAL - Analyst Report ) with 14.2% of assets. International airlines also make up a sizable chunk of assets as well, as Singapore Airlines and All Nippon Airways both take up about 4.5% while Lufthansa also sneaks into the top ten with a 3.8% holding (also see Africa ETFs: Three Ways To Play).

Still, FAA should serve as a good proxy for the broad airline industry, both at home and abroad. While it remains to be seen how the filing will impact the other carriers, many have been reacting positively to the news so far. DAL was up over 3.3% while UAL surged by over 6% on the news. However, it wasn’t all good across the board as Southwest was flat on the day, losing about one cent in early trading. Nevertheless, the outperformance of the other legacy carriers helped to carry the Guggenheim fund on the day, pushing FAA up about 1.5% in early Tuesday trading. These broad gains are likely due to hopes of lower competition with American in key hubs, and were probably the driving force for UAL’s impressive performance. In fact, American shares two hubs with United/Continental and one with Delta, suggesting that if gates are ceded to other airlines it could make it easier for UAL and DAL to surge at these important locations. Either way, FAA should be a fund to watch in the weeks ahead as the fallout from the AMR bankruptcy is fully known and industry participants figure out how best to move forward in light of this bombshell from one of the world’slargest airlines (also see German Bond ETFs In Focus).

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Author is long LUV.