OptionPundit

Tag: Option Trading Strategy

  • How to Play $100 Buyout of BNI?

    Warren Buffett’s Berkshire Hathaway (BRK.A) said Tuesday that it will acquire the remaining shares of railroad operator Burlington Northern Santa Fe (BNI) that it doesn’t already own for $100 per share in cash and stock in a deal valued at approximately $44 billion.

    “Our country’s future prosperity depends on its having an efficient and well-maintained rail system,” said Berkshire CEO Warren E. Buffett. “Conversely, America must grow and prosper for railroads to do well. Berkshire’s $34 billion investment in BNSF is a huge bet on that company, CEO Matt Rose and his team, and the railroad industry.”

    “Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Buffett. “I love these bets.”

    Closing of the transaction is expected to occur during the first quarter of 2010. And that’s where I want to use it for a trade idea.

    (more…)

  • OPNewsletter (Oct’09) Up +9.5%

    88.7% capital invested, no major adjustment needed, all but one portfolios made money and closed, 1 portfolio still open (down -2.9%), OPNewsletter delivered +9.58% x -commissions and +7.8% including commissions. As good as it gets. We are starting to look out and analyze opportunities for November 2009 income portfolio. If you are not an OPNewsletter member and would like to join, pls sign-up for the waitlist here.

    These results don’t include returns from speculative trades i.e. bonus alerts.  I shared trade ideas on GOOG and GLD. While GOOG trade required adjustment as GOOG quickly bounced from 480s  (I didn’t close the trade), GLD trade is working excellent.

    Gold is decidedly above $1,000 while USD is continuing to weaken.  For the stock markets, while a debate is going on between the Bulls and Bears, there don’t seem to be a clear technical sign for any major top. Personally, I don’t belong to the Bulls camp but I am not short this market either.

    Looking forward to an action packed earning’s week. I am likely to play a few counters for earning related moves. Stay in touch.

    Profitable Trading, OP

  • How to Play Alcoa (AA) Earnings?

    Aloca (AA) is set to announce earnings after close today. Wall Street is expecting a fall to -$0.55 to -$0.57 EPS depending upon who do you follow (Zacks, First Call etc). The quarter was not that exciting, hence the expectation are already factored for a very poor quarter. I think the movement will depend on the extent of swing of losses in either direction. My personal bias is that will beat these lowered numbers (probably on ground of higher discounts to liquidate inventory, etc.) . Worth watching though is the Gross/operating Margins.

    Earnings related trades are speculative and hence there is 50/50 chance of being correct. So, How to play this?

    aa-earnings-apr-09Earlier I mentioned about a beautiful strategy to play large moves, called “Backspread” strategy. Here is a Trade Idea-

    While I would like to play upside I also want to protect myself for any negative announcement and hence negative stock reaction. I am planning to open a April 6/7.5 2:3 Call ratio spread i.e. Sell Apr Calls 2X and Buy April 7.5 Calls 3X. This will yield about $1.50 credit. The Max I can lose by April expiration is $150. My break even points are $6.73 and $9 by April expiration.  As long as AA moves beyond this range, this trade will be able to make money.

    What’s the catch– Tomorrow morning the IV will drop like a stone as the news will be out and stock will move. The worse case, the IV drops and stock doesn’t move. For this trade to make money, stock has to move.

    There are other ways to book profits. For instance, if AA drops heavily then close the 6 calls buy buying it back cheaper and sell the 7.5calls when AA bounce a little upwards. But this all requires intra day trading skills/maneuvering.

    Don’t try this if a) you are not willing to lose and b) you don’t how to profit from it even if it goes against your plan.

    Disclaimer– As of this writing I own this spread. I may change my position anytime without notice.

    Profitable Trading, OP

  • OPNewsletter- Mar’09 +8.8%, Apr +2.4% (Open)

    March’09 portfolios were closed +8.8% (excluding commissions) and +5.6% (including commissions). I used up about +46.7% of the assumed 10K capital for OPNewsletter. This result doesn’t include excellent results from bonus trade alerts.

    market-movement-mar09-opn-portfolio When compared with broader markets, this was probably one of the best months for OPNewsletter. Look at the major market movements since we opened the Mar (Mid Feb’09) portfolio. RUT traveled almost -20% south; and DOW, S&P500 and Nasdaq ranging from -14% to -16%. All this was followed by sharp snap back rallies. Isn’t this amazing, almost 20% back and forth move in one month. I have not researched to find if this is one of its kinds or has happened before. But whatever be case, this is not income trader’s best friend. This was surely not an easy period. In fact one of the toughest and most volatile periods, at least of my lifetime (leaving aside Oct 1987 crash). Hence preserving capital and delivering just positive results itself is good enough. One of the strategy I used was to focus only what was opened and keep cash free to make adjustments as needed. This served nicely without really triggering panic due to shortage of capital. For Option Trading Strategies, We used multiple strategies i.e. Calendars, Credit Spreads, Digonal Spreads and so on. I however, decided not to open an Iron Condor this month anticipating extreme movements which also served nicely (There is not a single losing Iron Condor since re-opening of OPNewsletter).

    For OPNewsletter, The best performing portfolio was USO which delivered +22.8% and it was also rolled over to Apr. I expect this portfolio to deliver +50% by July. The worst portfolio was ABT which was almost break-even (+0.89%). MCD delivered +5.5%. A tough month though, it required greek’s analysis, technical analysis, gut feel and past experiences with similar situation (VISA, May 2008) helped sail through this month.

    Some of the excellent intraday trades, results not included in OPN tracking, were +42% on SRS, +58% on VIX, CF arbitrage of $6, DECK for +220%, AZO (+27%, +39%, +73%), SKF +20% to +50%, FDS lost to break-even, NKE earnings +22%, DELL earnings amongst others. As mentioned, These results are not part of OPN tracking.

    We are nicely positioned for Apr’09 portfolios as well and so far invested only +19.7% of assumed 10K capital. I shall be opening a few more portfolios next week, if you would like to join, pls sign-up for the OPN waitlist.

    Those who could trade intra-day, markets offered wonderful trading opportunities, specially on the Expiration day. A smiling butterfly was shared with all the free members as well, that resulted into >+100% gains. Hope folks who followed invescafe/speculative trade alerts (some of those listed above), probably had some good opportunities that I played for intraday trades.

    (You may want to sign-up for the Basic Membership (Free until Dec 2009) that I use to share free trade alerts for registered members).

    I have been experimenting with several underlying/strategy combos over past 3-4 months, with real money. I think I am ready for opening new Portfolios/newsletter(s) to take advantage from current environment. I shall share more on this later.

    One final message, markets are not out of woods yet, pls don’t let complacency set-in, these are extraordinary time and it requires one to be taking extraordinary steps.

    Trade Carefully, Trade Profitably, OP

  • A Covered Call with Ultrashorts

    It is generally assumed, and rightfully so, that Ultrashorts SRF, SKF are not for everyone, those are highly volatile and average investors should stay away from those. However, I think, if managed properly, these can also be valuable tool to generate passive income.

    Firstly, let’s look at the 2 popular ultrashorts SKF, SRS. Attached charts are pictorial view of how volatile these stocks are. SKF (Ultrashort Financials) has a trading range of $100 to $300 and SRS (Ultrashort Real-Estate) from $50 to $250 and intraday movements are good enough to stir stomach muscles. As such general markets are speculative these days and on top of it ultrashort nature makes these even doubly volatile; and if you are doing options on it, that simply magnifies volatility exponentially.

    That’s where as an option trader, this volatility comes to my advantage. Here are a few things I need to assess EVERYTIME I am placing a trade-

    • Is this capital something I don’t need in foreseeable future (6-12months)?
    • What is the general market environment, Technical Analysis?
    • How much ATM option premium current environment is generating?
    • How long will it take for my stocks to become free?

    Let me take you through with a real covered call example that I placed on Jan 16th. The trade was opened purchasing SRS on average @ $61.15 and then I sold $60 Feb Calls for $10.85 average. This essentially resulted my effective price of $50.30. Since I am using portfolio margin facility, my cash outflow is almost half of $61.15 but let’s forget that for a moment.

    Attached Risk/Reward chart (approximate) show that this trade will be yielding nearly 17% for almost 4wks holding period assuming SRS remains over $60 (and based on last Friday’s prices). This trade will break-even at $50.30 below which I shall be making losses. Albeit, when It’s Feb’09 expiration, I can sell March’09 call ATM options as well (or earlier). However, the yield and subsequent losses will be determined at that point. What needs to be noticed is that in few month’s time, these stocks will be free to own. It is essentially like rental yield on a property that is bought for free.

    While this seems all good, there are watch-outs that one needs to be careful about.

    1. Risk premium is dependent on the prevailing Implied Volatility and the underlying price. It may take longer to recover investment in underlying.
    2. The risk/profile is only on expiration. Before expiration however, the sold call will still have time value and hence the losses might be more than what it might be on expiration day.
    3. Due to inherent characteristics of ultrashorts, the extreme movements can easily stir emotion. Hence it is beneficial to keep a risk management plan in place, in advance, all time.
    4. We are in the bearish markets and hence underlying are commanding high absolute price, but as the markets starts to calm, the absolute value will fall and it may happen that it never recovers to those high value.

    The same covered call can be done via naked put selling as well. I however like to combine the technical analysis to the option selling i.e. when SRS is about to turn up, I buy the stocks and sell the covered calls when stock might be turning downwards (the above case may or may not represent that). I can sell stocks and let the call value decrease and buy back stocks later. There are multiple ways this can be played.

    However, net-net, there are risks with ultrashorts and hence it is important to do proper due diligence and stress testing of your trade before you place one, in case you decide to follow. Above mentioned trade is for real and I may get out of the trade anytime depending upon risk/reward profile vis-a-vis other opportunity.

    You may want to explore it further to review if this is something you would like to add to your Option Trading Strategy toolbox. What do you think of this strategy? did you try this before? what kind of issues did you face?

    Profitable Trading, OP