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Long Shots

Every once in a while, it's fun to take a chance.

Today we made a play on YRCW where we sell the 2011 $2.50 puts for $1.75 and sell the 2011 $5 calls for .75, which net's us $2.50 on the $2 stock.  We like YRCW and think they are undervalued here but that's no reason to actually buy them in an uncertain market.  The nice thing about selling the 2 naked leaps is that we have collected $2.50 and our worst-case outcome to the downside is that the stock goes bankrupt and we owe the put holder $2.50 back – making this a null trade

Our real risk (our only risk) is to the upside.  Our strategy for managing that risk is to put a buy on YRCW at $2.50 and a sell on YRCW at $2.50.  In other words, we will buy it when it's breaking over and sell it when it's breaking under.   Each time we do this, we may lose a few pennies here and there but, if YRCW finishes over $2.50 by 2011, we will own the stock for free (we collected $2.50 and paid $2.50 for the stock) and will be called away at $5 – a VERY nice profit over 18 months.

Anything under $2.50 and we keep the net between $0 and the final price, giving the rest back to the put-holder.  This is not the kind of position we worry over, this is simply a play to collect $2.50 and, hopefully, never give it back!  Of course there are margin issues depending on your account situation that need to be considered.  This is a variation of the Buy/Write strategy we love to use, only without the buy.  If you did buy YRCW at $2 and sold the 2011 $5 calls and 2011 $2.50 puts for $2.50 then you would be in the trade for a credit of .50.  In the bankruptcy scenario there, you would have another round put to you at $2.50 and your average entry would be $1 – substantially more potential downside loss than selling naked.  On the upside, you are in better shape as your basis of -0.50 would net you a $5.50 profit if YRCW closes over $5 and you don't have to worry about getting blown out by a buyout of YRCW.

These kinds of plays are always risk/reward scenarios and, with that understood and out of the way – let's look at some more fun long-shot plays we can make:

C at $3.13. Rather than tie up $3.13 and risk a 20% loss.  Why not just buy the 2011 $2.50 calls for $1.14 and sell the 2011 $5 calls for .56.  That puts you in for net .58 – you can't possibly lose more than .58, even if C goes BK but, at $3.13 you collect .63 and you can get as much as $2.50 before your caller kicks in and caps your gains.  That's a potential $1.94 profit on .56 (364%) if Citigroup just gets back to $5 by Jan 21st 2011.  If you bought the stock for $3.13 and wanted that kind of return, you'd have to be selling at $14.52, 5 times the current price! 

The idea of strictly limiting your risk while maintaining a nice upside makes this a nice addition for a small, speculative portion of a virtual portfolio.  If you have 5% of your virtual portfolio on 5 speculative plays like this and  just 2 of them pan out, that would be +7% on 2 plays and -3% (assuming a wipeout) on the other 3 for net +4%, an 80% gain in 18 months on 5% of your virtual portfolio.  If you keep an eye on these trades, you can often pull the plug well before they lose half their value – another plus.

UYG at $3.87 seems like a risky proposition these days but they WERE $40+ in 2007.  We don't know if they'll get there again but let's say they can get back to $5.  Buying the 2011 $4s for $1.38 and selling the $5s for $1.12 is net .24 with a .76 max profit at $5.  Again, our goal is to limit risk to the 20% we would stop out at anyway while leaving ourselves a nice upside. 

You can offset a bullish financial play like UYG with a bearish one like FAZ, now $4.94.  Since we can assume we'll make .76 per .24 on the UYG play if FAZ drops in half over the same time-frame (as UYG only needs to gain 25% to win), we can buy FAZ and sell the 2011 $3 puts and calls for $4.35.  That puts us in for net .59 with an upside potential of $2.41 (called away at $3) and a worst case of having another round put to us for a $1.80 average entry.  So FAZ would have to fall $3.14 (63%) for us to be out our first penny.  Our FAZ upside of $2.41 pays for 10 UYG spreads and we only need 5 to make $3.80 which is more than we would lose FAZ was assigned to us and went to zero.  So a full paired hedge here could be:

  • Buy 100 FAZ for $494


    • Sell 2011 $3 puts and calls for $435 (net $59)
  • Buy 6 UYG 2011 $4s for $828


    • Sell 6 UYG 2011 $5s for $672 (net $156)

So we are out of pocket for $215 and if UYG finishes over $5, we collect $600 and FAZ may or may not retain value or, at worst, we would be forced to buy 100 more shares for $300 and would net $300 on $215 invested (39%).  Looking at the other side, if FAZ pays off, we collect $300 and we have no obligation on UYG so, again, no worse than 39% return over 18 months.  Is this foolproof?  No – it is possible that both UYG and FAZ for some reason go below our marks as ultra-ETFs are very strange things.  But they also could both finish all or partially in the money (both were much higher and lower than they are now) and then the rewards would be huge

This is hedging, a calculated risk with a high probability of success.  It's also nice as it's the kind of play you can walk away from without having to worry about it too much as you have winning bets placed in both directions.  Also, keep in mind you don't have to ride out FAZ to the bitter end (assuming they take the hit).  You can stop out any time with a small(ish) loss if you start getting very confident of your UYGs or you can, of course, roll out the long puts rather than pay them. 

As it's Father's Day tomorrow, what better gift to give Dad than a nice set of Callaway stock options?  Remember in March I liked HOG because it was stupid low at $7.95 for one of the greatest brand names in America?  Well, Callaway is to cart-riders what Harley-Davidson is to bike riders and it's trading at the low, low price of $5.36 after being savaged in Barron's at $6.25 on June 9th, after cutting dividends.  While not expecting them to make a lot of money, we have no reason to think they are going to lose any and they just raised $140M, which should see them through a rough patch. 

As we like owning stock of companies that usually pay a dividend (.28 a year) but stopped to save money – on the assumption they may do so again, I like the buy/write on them.  At $5.36, selling the ELY Nov $5 puts and calls for $1.85 nets $3.51/4.26, a 20% discount off the current price if put to you and a 42% profit in 5 months if called away.  If Callaway loses 60% of it's value and falls to $2 in November, you will own 2x at $4.26 and you can buy another round at $2 for an average entry of 4x at $3.13 – if you don't mind owning them long-term, that's not a bad deal.  Also, with a play like this, keep in mind that you can stop our of your stock position if they fail $5 and just get back in if they get back over.  That way, in a real drop, you lose .36 on the stock but you sold $1.85 so you are in for net -$1.49 and, if ELY is put to you at $5, your net entry is $3.51 – you don't have to be passive with these plays.  Meanwhile, if you need something more tangible for Father's Day, the new Callaway UPro is a pretty cool toy.



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  1. Phil:
    Along these lines: UAUA currently at $3.85. Sell 2011 $5 calls for $1.90 and $2.50 puts for $1.15, net $3.05. You’re up $.55 on BK, break-even at $8.05 w/o buying the stock at $5, which you would. Buy/sell stock as it crosses the $5 line, so keep the $3.05 if it finishes higher than $2.50.

  2. Phil:
    A question on stops: Am I correct that you have your stops converted to limit (versus market) orders when your stop is hit.? Each seems to have a downside. The limit order might not be filled. The market order is a market order on an option – generally not a good thing.

  3. I think the stops are mental stops. not actual ones.. you watch the market exercise the stop manually

  4. UAUA/Chaps – Hey that one is worth adding officially, I’ll go over that and write it up later.  You’re getting the idea, this can be applied to hundreds of stocks – the trick is to just find something that has (hopefully) bottomed out low enough that we can virtually eliminate the downside risk by selling leaps. 

    Stops/Chaps – Foss is right, they are mental stops (see Strategy section).  As you know, I try not to react to spikes so it dosn’t mean that at $2.50 on the button I will trigger a buy, it means that at $2:40 I wlll take a very serious interest in the action and, if I think it’s going to break up with momentum, I may even buy some then and hold for the test of $2.50 or I may watch a spike to $2.60 and do nothing, waiting for a test back at $2.50.  You just need to stay aware of your coverage and what you are risking with each nickel you let it go.  With YRCW, for example, we have collected a $2.50 credit with a $5 call away so I could let the thing go all the way to $4 and I’d be in for net $1.50 with a call away at $5 so not something to panic over at the $2.50 line. 

    Effectively you have free cracks at momentum trades since you have a $2.50 margin of error and, since your risk (at $2.50 to $4) is exclusively to the downside, that should dictate your strategy and you should only be interested in trying to catch upside moves with very tight stops on the turn down (since we fear the BK more than the buyout).  Also, keep in mind that every single .10 you gain makes it safer and safer to the downside and widens your upside spread by 4% so there’s nothing wrong with collecting .10 10 times – nothing at all wrong with an itchy trigger finger…

  5. Hi, Phil,
    Several months ago, I did a buy/write on FAZ, and ended up owning 600 shares of FAZ at the average of $11.45.  At the time, I was pretty bearish on financials, and didn’t mind to own some FAZ.  But now it has gone down to $4.71.  Do you have any suggestions?

  6. FAZ/Cwan – Well I would suggest doing something sooner than 50% later!  There is no reason to hold the stock now but you are down to $2,826 off $6,870, which is $4,044 behind.  If you want to play to get even or ahead while keeping a small hedge long-term, I would suggest the spread of the FAZ 2011 $3s at $2.88, selling the 2011 $4s at $2.60, which is .18 to make .82, a 455% profit.  So if you want, you can buy 50 contracts for $900 and those will give back $5,000 if FAZ holds $3 through Jan 2011.  Then you can move on and put the other $1,900 to more productive use. 

  7. Phil: Thanks for the advice.
    On the subject of "bottoming", what do you think of real estates and home builders?  How about REITs and companies such as TOL?

  8. foss/Phil stops: Thanks. I understand what you’re saying. I just went through this in spades with selling USO June calls naked and then covering/uncovering with the underlying. I had trades on at three different strike prices. I made money but, IMO, it wasn’t worth it. Too much monitoring and too many judgement calls to make. The underlying (USO) is too volatile and manipulated for this kind of trade at multiple strikes. I would think what we’re talking about here (e.g. YRCW)  is much more manageable with the underlying being the stock of a company (versus a commodity index) and a single strike price.

  9. C/Phil: How does TOS treat the margin requirment on such a spread?  Will they treat the spread as 2 separate trades, and regard the short calls as naked calls?

  10. C/TOS margin requirement: I tried it on TOS’s platform.  After looking at the confirmation page, it looks like they recognize this as a spread, and does not charge extra margin requirement.

  11. Good Morning Phil and all

  12. Asia/Pacific Markets    Monday, June 22, 2009
    (The following is from Yahoo, please confirm with other sources)   

    Australia All Ordinaries*             3910.80        16.40        0.42%
    Nikkei Average*                            9826.27        40.01        0.41%
    Shanghai Composite*                2896.30        15.81        0.55%
    Hang Seng*                                18059.55      138.62        0.77%
    Seoul Composite*                       1399.71        16.37        1.18%
    Singapore Straits Times*           2266.92        -6.26         -0.28%
    Bombay Sensex                         14302.27    -230.81        -1.59%
    Baltic Dry Index                             4070.00         -3.00         -0.07%

    *at Close

  13. Asian Stocks Tick Up, But Cautious Ahead of Fed

    Asian stocks edged up Monday, supported by buying of defensive sectors, while the U.S. dollar rose on caution ahead of a Federal Reserve meeting this week when policymakers may extend programs to keep borrowing costs low.

    Investors were also watching U.S. Treasury yields, which remained in a rising trend, ahead of a record $104 billion in government bond auctions this week to finance massive rescue spending on the economy.

    China’s imports of refined copper hit a record in May, up from a previous record in April and 258 percent higher than a year earlier. However, speculation spread that the pace of demand was unsustainable, and copper for delivery in three months on the London Metal Exchange fell $159 to $4,866 a ton.

    Japan’s Nikkei finished 0.4 percent higher, with brewer Sapporo Holdings and carmaker Nissan Motor making robust gains, though caution about a possible correction in the market remained strong.

    South Korea’s KOSPI closed 1.1 percent higher helped by gains in some technology issues on earnings hopes and banks, but caution ahead of the U.S. Federal Reserve’s interest rate meeting weighed on sentiment.

    Australian shares gained half a percent, buoyed by resource stocks and banks.

    Hong Kong’s Hang Seng Index was up 2.5 percent, after opening flat. Two initial public offerings — a scrap-metal recycler and a furniture maker — drew strong interest on their debuts in a market seeking fresh catalysts ahead of mid-year reports by fund managers.

    Singapore’s Straits Times Index rose 1.2 percent. Banks moved into positive territory, after Deutsche Bank raised its target prices for all three banks in the island-state, citing further improvement in net interest margins and signs of recovery in the residential property sector.

    China’s Shanghai Composite Index gained nearly 1 percent. Financial shares led the advance.Chinese spot steel prices rose to a near four-month high last week as demand recovered.

    Bombay Stock Exchange’s Sensex was at 14395.90, down 125.99 points or 0.87 per cent. Selling pressure in benchmarks intensified on Monday with poor opening of the European markets. The worst hit were oil & gas, power and metals stocks while banks and consumer goods bucked the trend.

  14. Oils Drag Euro Stocks Lower

    European shares were lower in morning trade on Monday, as weakness in energy stocks overshadowed gains in the miner Anglo American after Xstrata said it wanted merger talks. The pan-European FTSEurofirst 300 index of top shares was down 1.2 percent at 851.12 points, after gaining 1.3 percent on Friday.

    German Ifo index rose for the third month running in June to reach its highest level in seven months, but failed to lift the market.

    Miners added the most points to the index. Anglo American soared 9.1 percent after Xstrata said on Sunday it wanted talks with the group about a proposed merger of equals worth about $68 billion, seeking increased scale and cost synergies. Xstrata was down 4.3 percent. Other miners were hit by falling metal prices with copper down 1.7 percent. Antofagasta, BHP Billiton, Eurasian Natural Resources Corporation and Rio Tinto were 0.7-1.4 percent lower.

    Energy stocks were lower as crude fell to around $69 a barrel, extending the previous session’s drop of more than 2 percent. BG Group, BP, Royal Dutch Shell and Total were down 0.6-1.1 percent.

    Banks were also in the doldrums, although stocks within the sector were mixed. Banco Santander, Barclays, Deutsche Bank and UBS were down 1.1-1.8 percent.

    "Unless there is going to be bad news then no one is going to be driving the market in any particular direction," said Justin Urquhart Stewart, director at Seven Investment Management".

    Around Europe:

    FTSE     4,288.95    – 56.98        – 1.31%
    DAX       4,775.75    – 63.71        – 1.32%
    CAC      3,171.79    – 49.48        – 1.54%
    SMI        5,382.43    – 47.12        – 0.88%

  15. Oil Falls Toward $68 on Stronger Dollar, Stocks

    Oil fell toward $68 a barrel on Monday pressured by a stronger dollar and weaker European equities, but attacks on the oil industry in top African exporter Nigeria limited losses. Nigeria’s main militant group said on Sunday it had attacked three oil installations belonging to Royal Dutch Shell in the Niger Delta, widening a month-old offensive against Africa’s biggest energy industry.

    U.S. light, sweet crude [ 68.18    -1.37  (-1.97%)] for July, which expires later on Monday, fell. The contract fell more than 2 percent on Friday. London Brent crude [ 68.2    -0.99  (-1.43%)] was lower.

    European stocks lost ground and the dollar rose against a basket of other major currencies. A stronger dollar can limit the appeal of oil and commodities to investors. Chart patterns are also pointing lower for crude.

    Some analysts say the political turmoil in Iran, a major oil exporter, so far is of limited significance for the markets due to high levels of unused production capacity and inventories. Others see it as supportive. "The deterioration in the Iranian situation should prevent a sharper sell-off," said Edward Meir, analyst at MF Global.

    Crude oil speculators on the New York Mercantile Exchange slashed their net long positions nearly in half in the week to June 16, data showed on Friday. Long positions are bets that prices will rise.

    Euro Falls Ahead of ECB Refi Operation, Fed

    The euro slipped against the dollar and yen on Monday, and higher-yielding and commodity-linked currencies also fell on investor concern about global growth prospects. The euro came under pressure as the market awaited the European Central Bank’s first ever one-year refinancing operation on Wednesday aimed at getting banks lending again and reducing the cost of borrowing for banks, firms and consumers.

    Data on Monday showed German Ifo business climate index rose to 85.9 in June from 84.3 the previous month, beating forecasts of 85.2. The current conditions index was at 82.4, versus a forecast of 83.1. "The worst should be over but the ongoing improvement is likely to be too weak to seriously discuss a recovery," said Carsten Brzeski, economist at ING Financial Markets.

    The euro [1.3844    -0.0095  (-0.68%)    ] was down against the dollar after hitting a session low of $1.3848, according to Reuters data. It was also down versus the yen [ 132.92    -1.26  (-0.94%)    ] .

    Markets have drifted in the past few days as investors are still trying to decide if a three-month rally in riskier assets, including shares, has outrun the pace at which the global economy is healing.

    The Australian dollar fell against the U.S. dollar [ 0.7961    -0.0097  (-1.2%)   ] and the yen [  76.4    -1.17  (-1.51%)  ] . The New Zealand dollar [  0.6347    -0.0077  (-1.2%)   ] fell against its U.S. counterpart.

    The dollar [ 95.98    -0.25  (-0.26%)    ] was down versus the yen, after falling to around 95.80 yen earlier.

    Markets will also keep an eye on a record $104 billion in U.S. Treasury debt to be auctioned this week.

    Gold hovers around $933

    Gold was little changed on Monday, hovering around $933 an ounce as the dollar stayed within its recent range, with investors reluctant to chase the metal higher after it fell for three straight weeks.

    Gold was almost flat at $933.30 an ounce at 0425 GMT (12:25 a.m. EDT) from New York’s notional close of $933.80 and above a Friday low of $930.45.

    The world’s largest gold-backed exchange-traded fund, the SPDR Gold Trust, said its holdings stood at 1,132.15 tonnes as of June 19, unchanged since June 5.

  16. Good morning!

    REITs/Cwan - We shorted them on Friday so I’m not too enthusiastic.  I think that they have a very long, hard fight to get back up and a very easy, fast slide down if things get worse.  Builders not much different and we hear some earnings this week so better to see what’s up first before making bets.

    Stops/Chaps – For sure, USO and any commodity is for experienced traders only and we get burned plenty on them.  If you don’t have a strategy for haing it go the wrong way on you for 3 months, you are likely to get in trouble.

    TOS/Cwan – I’m not sure how it differs from account to account but their requirements seem better (less) than most.

    I have a hard time classifying China as an up day when they dropped over 300 points into the close and were saved by the bell.  Notice they are still talking about May copper imports, where we peaked out 3 weeks ago – very old news….