Steven Sears Striking Price column started out with the headline, VIX Signals Many 4% Daily Moves. The way I feel about the VIX is similar to the way a dog feels when you say in a high pitched tone, “Want a treat?” Any mention gets my attention. What he’s stating in the column is that the VIX at its current high level in the 40’s is pricing in relatively large daily market moves as indicated by the S&P 500. This also means that options on individual stocks are pricing in large fluctuations over the next few months. One example is options trading on Coca-Cola (KO – 67.42). Two option selling strategies are highlighted as high relative option prices can make selling strategies pretty attractive.
First, with elevated implied volatility, a long term bull on KO may get paid to purchase shares at a more attractive price. This occurs by sell a put which results in the obligation to purchase shares is assigned on the contract. Based on Friday’s prices, a January 62.50 Put may be sold for around 2.20. If KO is below this level at expiration a seller may be assigned and end up purchasing shares at a net cost of 60.30 (62.50 strike – 2.20 premium received).
The other option selling strategy that was suggested involves either owning or purchasing shares and selling a call against those shares. The February 70 Call was bid for at 2.65 on Friday and this contract could be sold against shares that are trading at 67.42. If the stock is below 70.00 at expiration the shares would be retained and the contract would expire. With shares above 70.00 at expiration your shares would be sold at a net effective price of 72.65 (70.00 strike + 2.65 premium received) which is higher than the stock’s 52 week high of 71.77.
Options Action –
The first stock discussion focused on Hewlett-Packard (HPQ – 22.35) which named Meg Whitman as CEO. The feeling is the stock has fully priced in negative company specific news and is at a good long term valuation to take a long position. The trading recommendation is for a bull call spread which involves buying a lower strike call and selling a higher strike call option. The specific trade involves buying the HPQ Jan 24 Call at 1.75 and selling a HPQ Jan 29 Call for a credit of 0.55 which results in a net cost of 1.20. This strategy results in a profit if HPQ is above 25.20 at January expiration and potential profits capped with the stock at 29.00 or above at expiration.
The next recommendation involves the energy sector in the form of a position in Halliburton (HAL – 31.67). This is a bullish trade as well. The stock is down 45% from highs a few months ago which reflects pressure on energy prices. The trade recommended is a call spread risk reversal. This is a complex trade that involves buying a low strike call, selling a higher strike call and finally selling a lower strike put. The result may be getting long the stock at a lower price based on further weakness or benefitting from a rally in the through the spread created with the two call options. The trade recommended stipulates buying a HAL Jan 33 Call at 3.90, selling a Jan 36 Call at 2.65 and selling a Jan 22.50 Put at 1.25. The net cost is neither a debit nor credit excluding commissions. The maximum profit at January expiration to the upside occurs at 36.00 with a 3.00 profit. Partial profits may be realized between 33.00 and 36.00. Finally, on the downside, a trading loss may occur if the stock is below 22.50 at expiration and if the spread is held through expiration the result would be a long position in HAL with a cost of 22.50.