We would like to welcome Schaeffer’s Investment Research and Elizabeth Harrow, editor at SchaeffersResearch.com, to the CBOE Community. This is their first blog with us. Bernie Schaeffer is a long-time friend of the CBOE and The Options Institute and Elizabeth is a terrific writer. We are thrilled to have their input and we hope you enjoy their contributions.
Ford Motor (F – $14.98) has emerged as a technical laggard in 2011, with the stock down 11% year-to-date. By contrast, the broader S&P 500 Index (SPX) is up about 4.5% since the beginning of the year. Nevertheless, one enthusiastic options trader on Tuesday placed a bet on bullish price action by constructing a long call spread on the U.S. automaker.
Specifically, the trader purchased a block of 1,000 May 15 calls for the ask price of $0.67, and simultaneously sold a block of 1,000 May 16 calls for the bid price of $0.28. The net debit on the play is $0.39, or $39 per pair of contracts. This initial net debit is the most the spread trader stands to lose, even if Ford shares should drop to zero prior to May expiration.
On the other hand, the maximum potential profit on this debit spread is limited, as well. The most the speculator stands to make is limited to the difference between the two strike prices, less the initial net debit — in this case, $0.61, or $61 per pair of contracts.
The best-case scenario in this strategy is for F to settle squarely at $16 upon May expiration. This will reap the maximum potential profit on the purchased call, while the sold call could be left to expire worthless. The profit will remain the same even if F should go vertical and finish at $50, but the trader will incur an additional fee to close out the sold call in such a scenario.
With F trading near $15, this might not seem like the most boldly optimistic play. However, Ford has been dropping under pressure from its 10-week and 20-week moving averages since late January, with this trendline duo completing a bearish cross in mid-March. These moving averages are located near $15 and $16, respectively, so Ford will need to conquer both looming resistance levels in order for this spread strategy to turn a profit.
Perhaps this cautiously optimistic spread strategist is encouraged by Ford’s recent bounce from support at its longer-term 10-month moving average, which is perched near $14.40. On the other hand, this could also be a bullish pre-earnings play on the auto heavyweight. While the company has yet to confirm an official date, Ford is tentatively expected to report its first-quarter results on April 25, according to Thomson Reuters. Plus, April sales figures are due out May 3 at midday, representing another potential short-term catalyst for the shares. Both dates fall between April and May expiration.
From a broader perspective, Tuesday’s bullish spread was a deviation from the norm for Ford. The stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.74 stands in the 77th percentile of its annual range, indicating that near-term speculators have been more put-heavy just 23% of the time during the past year.
Likewise, short interest on the automaker rose by 1.9% during the most recent reporting period, and these bearish bets now account for a respectable 4.5% of the stock’s float.
Of course, given Ford’s technical troubles in 2011, this rising tide of skepticism isn’t terribly surprising. However, with the shares perched above familiar support at their rising 10-month trendline, it’s encouraging to see some negative sentiment building around the stock. Any good news from the company could lure some of these cynics off the sidelines, potentially providing Ford with a fresh influx of buying pressure.
Finally, I asked Bernie Schaeffer for a quick assessment of this long vertical spread strategy. “I’m generally not a big fan of long vertical spreads. While you do reduce your break-even point relative to a straight option buy and thus increase your probability for a profitable outcome, you lose the so-called ‘convexity’ of a pure long option position that allows you to profit at an accelerating rate on a big move by the underlying in your predicted direction," explained Bernie. "As you say, the profit on this trade is the same with Ford at $50 at May expiration as it would be with Ford at $16. Plus, you are still risking a total loss if the stock is flat or lower — and if the stock makes a quick move above the 16 strike you will not realize your full profit potential, because of the time value retained by the 16-strike call you sold.”
Elizabeth Harrow is the editor at SchaeffersResearch.com. Schaeffer’s Investment Research has been a leader in the options industry since 1981, providing investors with education, news, and real-time trading recommendations. Founder and CEO Bernie Schaeffer is widely recognized as an expert on equity and index options, investor sentiment, and market timing. The cornerstone of Schaeffer’s methodology is Expectational Analysis®, using a combination of fundamental, technical, and sentiment indicators, and these indicators as they apply to options trading are explored in each issue of Schaeffer’s SENTIMENT magazine.