Playing the Expiry: October 26, 2012
Technology companies are getting no love from traders so far this earnings season. Google (GOOG), Microsoft (MSFT), and Intel (INTC) finished the week on sour notes with gloomy reports and that hurt the NASDAQ substantially. And it might be another week of pain for investors as more tech stocks are starting to report.
Household names will be reporting this week, including Facebook (FB) and Netflix (NFLX) on Tuesday, and Apple (AAPL) and Amazon (AMZN) on Thursday. This week will definitely prove to be a turning point for the American markets.
Reporting earnings after hours on Tuesday, expect Netflix (NFLX) shares to make a big move. This stock has a very high beta and a 5 per cent move in an hour is not unheard of. That's why option premiums are so delicious for sellers. The last four earnings reports have moved shares at least 17 per cent, with the biggest move occurring last year on this date, falling about 35 per cent.
Trading Netflix is not for the faint of heart, and for those looking to get into options trading, I highly recommend due diligence. Credit spreads to maximize losses might be a wiser approach than simply writing a strangle, but of course this eats away at potential profits.
Before we begin to write the credit spread, we must examine the risks and rewards. Netflix at-the-money options are pricing in a 16 per cent move, but I would suggest protecting yourself from a 20 per cent move. With shares currently at $68.25, that gives us a range between $81.90 and $54.60. The nearest strike prices would be the 80 call and the 55 put. The premiums on the call and put are $0.99 and $0.70 respectively, yielding against the stock price, a return of 2.48 per cent, but more accurately, yielding a return of 6.21 per cent against margin. Because the options are so out of the money, the net margin required would be about $2,600 per pair of legs. But just remember that Netflix is a 50 per cent marginable stock.
The second step in a credit spread is buying further out-of-the-money options to maximize your loss. In this scenario, the exchange has only provided one choice. A trader would buy the 85 call for $0.44 and 50 put for $0.26 to provide a net credit to the account for $0.61 and $0.44. This limits the yield to 1.54 per cent against the stock price, but yield on margin rises to 26.7 per cent (margin required is the maximum loss [$500] minus premiums [$105] or $395). Yield on margin is a more accurate measure of returns, since that is the actual cash required to implement the trade.
Similar to the naked strangle (that is, the trader does not implement the buying of options), the profit range is still the same. If Netflix remains between $55 and $80 by Friday, full premiums are collected. The main difference is that the margin on the credit spread is reduced substantially, but has a tighter break-even range.
Intel, eBay, Microsoft Earnings Due This Week
Playing the Expiry: October 20, 2012.
The condition of the technology sector will be in focus this week as Intel (INTC), eBay (EBAY), and Microsoft (MSFT) will report third quarter earnings. Analyst predict that this quarter's earnings will be soft and may be lowered than expected. Last week, Advanced Micro Device's (AMD) management admitted that their third quarter earnings, due October 18, will be much lower than guided, knocking the stock to a 3-year low. And it could go lower when the official numbers are reported because management often puts a positive spin on things.
But we'll have to wait a few days for those reports. In the mean time, three bigger stocks with opportunities await, and here at this blog, we only care about the knee-jerk reaction by traders following earnings. Let's examine the three stocks that could make you some serious coin. Note, all three stocks report after-hours.
Intel - Tuesday
The shares fell in sympathy when AMD informed investors of a weak quarter. The sell-off means that a disappointing quarter has been partially priced in and there is a chance the shares will rise. Conversely, on the bullish side, the shares have been sliding for the past month and chart traders will note that the stock is trading at the bottom of the Bollinger Bands. There could be a short-term tug of war post-earnings with fundamentals wanting to sell and technicals suggesting a rebound. This means the stock could essentially trade very flat and option sellers may have a good pay day if this transpires.
Intel is a stock that often closes the gap retracing any drop and falling after a rebound, so taking assignment and waiting it out is an alternative to taking a loss or closing out any potential in-the-money position. We propose selling the 22.50 calls and 21.00 puts. Based on Monday's close, the premiums were $0.19 and $0.22 respectively with the stock at $21.73. That will earn you 7.36 per cent return on margin and a break even range of $22.91 to $20.59 or upside protection of 5.43 per cent and downside protection of 5.25 per cent.
eBay - Wednesday
This online retailer and auctioneer typically rises on earnings. In fact, the shares have risen all four times in the last year after earnings, which could indicate a trend. The rises have either been sharp or tame so upside protection will be very important here. It may even be wiser to ignore the call option altogether, but this could also limit your profitability.
The range of protection I see fit is 7.5 per cent and increased volatility has also increased option premiums. The shares closed at $47.40; selling the 50.00 call and 45.00 put will provide the protection needed. The premiums are $0.49 and $0.57 respectively. Total payout on margin is 9.35 per cent; break-even is $51.06 to $43.94 or +7.72% to -7.30%.
Microsoft - Thursday
Shares of Microsoft often remain within the trading range depicted by the Bollinger Bands. As a result, a trader could simply sell the call at the upper band price and the put at the lower band price. However, Microsoft has very poor premiums and this is the least promising trade. To earn at least 1 per cent return on market value means the trader has to sell the 30 call and 29 put for $0.21 and $0.23 respectively. The break even range is $30.44 to $28.56 or +3.15% to -3.22%. The return on margin is 5.45 per cent, which is still attractive, however, the low break-even range is a concern.
Good luck.
The condition of the technology sector will be in focus this week as Intel (INTC), eBay (EBAY), and Microsoft (MSFT) will report third quarter earnings. Analyst predict that this quarter's earnings will be soft and may be lowered than expected. Last week, Advanced Micro Device's (AMD) management admitted that their third quarter earnings, due October 18, will be much lower than guided, knocking the stock to a 3-year low. And it could go lower when the official numbers are reported because management often puts a positive spin on things.
But we'll have to wait a few days for those reports. In the mean time, three bigger stocks with opportunities await, and here at this blog, we only care about the knee-jerk reaction by traders following earnings. Let's examine the three stocks that could make you some serious coin. Note, all three stocks report after-hours.
Intel - Tuesday
The shares fell in sympathy when AMD informed investors of a weak quarter. The sell-off means that a disappointing quarter has been partially priced in and there is a chance the shares will rise. Conversely, on the bullish side, the shares have been sliding for the past month and chart traders will note that the stock is trading at the bottom of the Bollinger Bands. There could be a short-term tug of war post-earnings with fundamentals wanting to sell and technicals suggesting a rebound. This means the stock could essentially trade very flat and option sellers may have a good pay day if this transpires.
Intel is a stock that often closes the gap retracing any drop and falling after a rebound, so taking assignment and waiting it out is an alternative to taking a loss or closing out any potential in-the-money position. We propose selling the 22.50 calls and 21.00 puts. Based on Monday's close, the premiums were $0.19 and $0.22 respectively with the stock at $21.73. That will earn you 7.36 per cent return on margin and a break even range of $22.91 to $20.59 or upside protection of 5.43 per cent and downside protection of 5.25 per cent.
eBay - Wednesday
This online retailer and auctioneer typically rises on earnings. In fact, the shares have risen all four times in the last year after earnings, which could indicate a trend. The rises have either been sharp or tame so upside protection will be very important here. It may even be wiser to ignore the call option altogether, but this could also limit your profitability.
The range of protection I see fit is 7.5 per cent and increased volatility has also increased option premiums. The shares closed at $47.40; selling the 50.00 call and 45.00 put will provide the protection needed. The premiums are $0.49 and $0.57 respectively. Total payout on margin is 9.35 per cent; break-even is $51.06 to $43.94 or +7.72% to -7.30%.
Microsoft - Thursday
Shares of Microsoft often remain within the trading range depicted by the Bollinger Bands. As a result, a trader could simply sell the call at the upper band price and the put at the lower band price. However, Microsoft has very poor premiums and this is the least promising trade. To earn at least 1 per cent return on market value means the trader has to sell the 30 call and 29 put for $0.21 and $0.23 respectively. The break even range is $30.44 to $28.56 or +3.15% to -3.22%. The return on margin is 5.45 per cent, which is still attractive, however, the low break-even range is a concern.
Good luck.
Third Quarter Earnings Options Logbook 2012
Third-quarter earnings unofficially kicked off with the usual Alcoa (AA) reporting on Tuesday October 9, 2012. Over the next several weeks, companies will release earnings that will provide us a glimpse of the strength or weakness of global economic strength. Other issues include JPMorgan's "London Whale," if Apple can maintain market share with Samsung biting at its heels, and if the PC is dead, a recurring theme in the second quarter.
Total earnings for the season: $1,035.03.
Total earnings for the season: $1,035.03.
| JPMorgan & Chase (JPM) | |
| Trade Date: October 11, 2012 | Reporting Date: October 12, 2012 BMO |
| Closing Price Pre-Earnings: $42.10 | Closing Price Post-Earnings: $41.62 |
| Sold 5 42.50 calls at $0.40; expiring October 12, 2012 | |
| JPM finishes week at $41.62 | |
| Margin required: $5,966 | |
| Net profit of $183.75 or 3.08% | |
| Intel (INTC) | |
| Trade Date: October 16, 2012 | Reporting Date: October 16, 2012 AMC |
| Closing Price Pre-Earnings: $22.35 | Closing Price Post-Earnings: $21.79 |
| Sold 10 22.50 calls at $0.33, sold 10 21.50 puts at $0.19; expiring October 20, 2012 | |
| INTC finishes week at $21.26 | |
| Margin required: $5,970 | |
| Net profit of $330.02 or 5.53% | |
| Note: Options closed early to free up margin | |
| eBay (EBAY) | |
| Trade Date: October 17, 2012 | Reporting Date: October 17, 2012 AMC |
| Closing Price Pre-Earnings: $48.20 | Closing Price Post-Earnings: $50.83 |
| Sold 5 50.00 calls at $0.56, sold 5 46.00 puts at $0.59; expiring October 20, 2012 | |
| EBAY finishes week at $49.97 | |
| Margin required: $5,900 | |
| Net profit of $521.26 or 8.83% | |
| Note: Call option closed at $0.01 on Friday near market close | |
| Netflix (NFLX) | |
| Trade Date: October 23, 2012 | Reporting Date: October 23, 2012 AMC |
| Closing Price Pre-Earnings: $68.22 | Closing Price Post-Earnings: |
| Sold 4 80.00 calls at $1.05 and bought 4 85.00 calls at $0.44, sold 4 55.00 puts at $0.70 and bought 4 50.00 puts at $0.26; expiring October 26, 2012 | |
| NFLX finishes week at $49.97 | |
| Margin required: $1,640 | |
| Expected net profit of $360.00 or 21.95% | |
How to Buy Stocks Without Spending Cash
Education goes a long way in business and investors with knowledge will always have the upper hand. That is why more and more traders have abandoned the "buy and hold" strategy and are replacing it with a less commonly discussed strategy known as a synthetic long.
The strategy mimics a long equity position through the use of options. Two bullish trades are executed that require significantly less capital yet carries the same risks and reward.
The first part of the strategy requires the purchase of a call option, known as the long call. If the trader is correct, the long call will rise as the stock rises. The second part requires the sale of a put option, known as the short put. If the trader is correct, the short put will decrease in value as the stock rises. Shorting (or writing) a put option may require upgrades to your margin account so verify with your brokerage.
Since we are replicating a long-term purchase, it is prudent to use LEAPS (Long-term Equity Anticipation Security). LEAPS are long-term options and typically expire in January of a future year. In fact, LEAPS are already available for expiration on January 17, 2015.
Shares of Apple [AAPL:NSD] closed October 2, 2012 at $661.31. The purchase of a board lot (100 shares) would require an initial investment of $66,131, but not all investors have the capital nor the income to pay interest on borrowed money for such a purchase. As a result, Apple is a good candidate for the synthetic long.
Long Equity
An investor looking to buy the shares would require the $66,131 up-front or could borrow on margin with a minimum deposit of $19,840 (30% margin requirement) but would pay interest on $46,291. Total margin required is a minimum of $19,840.
Synthetic Long
Another investor looking to create a synthetic long would require a deposit equal to the margin required to purchase the call option and the margin required to sell a put option. Using a strike price of 660 for both options, we find the call option is asking $102.50 and the put option is bidding $106.60. Now that we have this information, let us examine the steps and margin requirements.
Step One: Long Call
The Jan 2015 660 call option would be purchased for $10,250 to mimic 100 shares of Apple. A hefty price, but a fraction of the stock holder's initial payment. Total margin required is $10,250.
Step Two: Short Put
The Jan 2015 660 put option would be sold for $10,660 to mimic 100 shares of Apple. The estimated margin required is $13,095 (to view the formula, click here under short uncovered puts or click here for the online calculator).
The margin required for a synthetic long is $23,755 and is equal to the minimum initial deposit. Another thing to note is that the synthetic long automatically generates $410. This investor would actually have $24,165 in the account while the long-term stock holder has paid at least $66,131 for Apple.
The reason that the option trader earns money today is because they forfeit their right to receive future dividends. The call option would discount the value of the dividends in its price calculating the value of time and interest, which is why the put option costs more than the call, even though the call is in-the-money. If you didn't get that, don't worry about it!
Two things can happen to a stock in 15 months. It can rise or it can fall.
If Apple rises, the long-term holder profits the difference in share price at sale and dividends received. The option trader would see the call option rise and be able to sell it; the put option would decrease in value and eventually be worthless. The option trader's profit is the gain (if any) in the value of the call option plus the entire value of the original sale of the put option.
For example, if Apple rises to $800 on January 16, 2015, the stock holder profits $13,869 and earns $331.25 in five dividends. This totals $14,200.25. Meanwhile, the option trader earns $3,750 on the call option plus $10,660 on the put option. This totals $14,410. As we see, the option trader will generate more income after dividends by $210 assuming the stock holder has not borrowed any money.
But what if Apple drops to $550? The stock holder loses $11,131 on the stock but earns $331.25 in dividends. This totals ($10,799.75). Meanwhile, the option trader loses $10,250 on the call option purchase and closes the put option at $110. The put option loses only $340. This totals ($10,590). As we see, the option trader loses less money in the same situation.
In the above example with Apple rising, both traders essentially earned the same amount of money, however, the option trader yielded nearly three times as much. The stock holder earned a handsome 21 per cent in 15 months, but the option trader earned more than 60 per cent in the same time period.
For new investors, the simple idea of an option is overly complicated, but for sophisticated investors, the strategy above is not so. We see that it is more efficient and yields better results, which is why we're seeing a small shift in options trading versus long-term strategies.
The strategy mimics a long equity position through the use of options. Two bullish trades are executed that require significantly less capital yet carries the same risks and reward.
The first part of the strategy requires the purchase of a call option, known as the long call. If the trader is correct, the long call will rise as the stock rises. The second part requires the sale of a put option, known as the short put. If the trader is correct, the short put will decrease in value as the stock rises. Shorting (or writing) a put option may require upgrades to your margin account so verify with your brokerage.
Since we are replicating a long-term purchase, it is prudent to use LEAPS (Long-term Equity Anticipation Security). LEAPS are long-term options and typically expire in January of a future year. In fact, LEAPS are already available for expiration on January 17, 2015.
Shares of Apple [AAPL:NSD] closed October 2, 2012 at $661.31. The purchase of a board lot (100 shares) would require an initial investment of $66,131, but not all investors have the capital nor the income to pay interest on borrowed money for such a purchase. As a result, Apple is a good candidate for the synthetic long.
Long Equity
An investor looking to buy the shares would require the $66,131 up-front or could borrow on margin with a minimum deposit of $19,840 (30% margin requirement) but would pay interest on $46,291. Total margin required is a minimum of $19,840.
Synthetic Long
Another investor looking to create a synthetic long would require a deposit equal to the margin required to purchase the call option and the margin required to sell a put option. Using a strike price of 660 for both options, we find the call option is asking $102.50 and the put option is bidding $106.60. Now that we have this information, let us examine the steps and margin requirements.
Step One: Long Call
The Jan 2015 660 call option would be purchased for $10,250 to mimic 100 shares of Apple. A hefty price, but a fraction of the stock holder's initial payment. Total margin required is $10,250.
Step Two: Short Put
The Jan 2015 660 put option would be sold for $10,660 to mimic 100 shares of Apple. The estimated margin required is $13,095 (to view the formula, click here under short uncovered puts or click here for the online calculator).
The margin required for a synthetic long is $23,755 and is equal to the minimum initial deposit. Another thing to note is that the synthetic long automatically generates $410. This investor would actually have $24,165 in the account while the long-term stock holder has paid at least $66,131 for Apple.
The reason that the option trader earns money today is because they forfeit their right to receive future dividends. The call option would discount the value of the dividends in its price calculating the value of time and interest, which is why the put option costs more than the call, even though the call is in-the-money. If you didn't get that, don't worry about it!
Two things can happen to a stock in 15 months. It can rise or it can fall.
If Apple rises, the long-term holder profits the difference in share price at sale and dividends received. The option trader would see the call option rise and be able to sell it; the put option would decrease in value and eventually be worthless. The option trader's profit is the gain (if any) in the value of the call option plus the entire value of the original sale of the put option.
For example, if Apple rises to $800 on January 16, 2015, the stock holder profits $13,869 and earns $331.25 in five dividends. This totals $14,200.25. Meanwhile, the option trader earns $3,750 on the call option plus $10,660 on the put option. This totals $14,410. As we see, the option trader will generate more income after dividends by $210 assuming the stock holder has not borrowed any money.
But what if Apple drops to $550? The stock holder loses $11,131 on the stock but earns $331.25 in dividends. This totals ($10,799.75). Meanwhile, the option trader loses $10,250 on the call option purchase and closes the put option at $110. The put option loses only $340. This totals ($10,590). As we see, the option trader loses less money in the same situation.
In the above example with Apple rising, both traders essentially earned the same amount of money, however, the option trader yielded nearly three times as much. The stock holder earned a handsome 21 per cent in 15 months, but the option trader earned more than 60 per cent in the same time period.
For new investors, the simple idea of an option is overly complicated, but for sophisticated investors, the strategy above is not so. We see that it is more efficient and yields better results, which is why we're seeing a small shift in options trading versus long-term strategies.
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