Calculated Risk on Netflix, IBM, and Yahoo!

Playing the Expiry: October 7, 2011

The American markets barely escaped bear market status yesterday afternoon when equities rallied more than 3 per cent in the final hour of trading. That was followed by another round of buying today which led markets higher by more than 1 per cent. So, with the markets showing some upward stability and support in these areas, is it time to start writing puts? The answer is yes.

After several weeks of massive volatility, yet very sideways trading, the market has been able to show strength at lower levels, and although the charts are still trending downwards, increased put activity and premiums are become attractive once again. It's time for another installment of Playing the Expiry for October 7, 2011.

Before the markets surged on Tuesday, I attempted to write puts on Microsoft which was trading close to $24. Over the last two years, the stock has shown significant support at these levels and has risen to nearly $28 every time. The stock has gone sideways which is perfect for trading. Unfortunately, I could not get a fill and the stock rose to $26 over the past 24 hours. However, continue monitoring the price-action for future opportunities.

With that trade missed, I chose to go a little riskier and selected Netflix [NFLX:NSD] instead. The stock plummeted from $300 to $110 in a matter of weeks, but is showing support at these prices. Consider writing a 115 put for the remainder of the week. At close, the bid on the puts were $1.25 with the shares at $119.76. Based on the stock price, this pays out 1.04 per cent over the next two days. This also provides protection of 5.02 per cent. That is, the stock must fall 5 per cent or below $113.75 by Friday's close before an investor would lose money. This payout and strong downside protection makes this trade very attractive. For disclaimer purposes, my fill was at $1.87.

If you're looking to go less risky, consider writing International Business Machines [IBM:NYSE]. The stock closed at $176.85, the short-term mid-range point. One may consider writing a put on IBM at 175. At close, the bid was $1.20. Against the market price, one would earn 0.67 per cent, with protection of 1.72 per cent. This may look less attractive, but IBM's stability and blue-chip status makes it easier to handle and it often avoids volatility, unlike Netflix. If the stock trades below $173.80, a loss could be absorbed, or you could consider rolling out the option to the next week or taking assignment and selling the shares once it rose back above your optimal price.

Going against the grain, one trade to consider could be Yahoo! [YHOO:NSD] call options. The stock surged in the afternoon today with rumours (again) that Microsoft would be dishing out the dough to acquire the company. The 16 calls for this week were bidding at close $0.45; the stock closed at $15.92. Many believe this rumour will turn out like it did in 2008, when Yahoo decided not to get bought out, only to see their stock fall 50 per cent since, but I digress. Writing these calls pays out 2.82 per cent for the next two days. Although the loss is unlimited if the shares rise, the odds of the rumour becoming reality by Friday are quite low. The stock would also have to rise 3.33 per cent before a loss would occur. Note, the stock is now at $15.33 in the after-hours market, so before attempting this, consider the values tomorrow.

Because I wrote this blog after the market closed, the values of all puts and stocks will vary tomorrow morning, but these are the three ideas that came to my mind today.

Disclaimer: Writing uncovered (or naked) options requires substantial margin and is only available to sophisticated traders. Uncovered calls have unlimited risk and can have infinite losses. Before making any trade, always discuss this with your advisor or professional broker. Reminder that all Playing the Expiry posts are transactions placed in my account and should not be taken as professional advice. As already mentioned, I have an uncovered put on Netflix.