I write this on a beautiful fall Saturday morning in Chicago. The one thing we know about weather in Chicago is that it will always change, even on an intraday basis, kind of like the news out of Europe these days.
The Striking Price column was written by Steve Sosnick of Timber Hill/Interactive Brokers this week. He was focused on the cost of hedging portfolios. The article discusses how expensive hedging is when you really think you need it. When there is more fear of the unknown in the market, like the current environment with the uncertainty coming out of Europe, the cost of protection in the form of put options is relatively high. The higher the CBOE Volatility Index (VIX), the more expensive protection in the form of SPX Puts will be. Again, the VIX is higher when there’s uncertainty, and that’s when you want the protection the most.
The cover story on Barron’s highlights a special section on Brazil. The feeling is the long term growth prospects for Brazil are very strong. If you agree with the bullish prospects laid out in the article an alternative may be the iShares MSCI Brazil Index (EWZ – 62.03) exchange traded fund. In addition to the ETF, there are LEAPS listed on EWZ that may be worth taking a look at.
Options Action –
The guys had an interesting piece of advice when starting out. Instead of discussing the overall market, they feel like it’s time to be more stock specific in your investments. Citing the overall market moves associated with the newest piece of news, the suggest focusing on the fundamentals of specific companies these days. Seems like a pretty solid piece of advice in the current market environment.
The first recommendation of the show involved Cisco (CSCO – 18.03). The company reports earnings next week and CSCO options are discounting a 6% move off earnings. The interesting note to this is shares have moved an average of 12.5% the day after earnings were released the last four quarters. The trading recommendation is a bullish play on earnings and a bull call spread. Using the November contacts the trade involves buying a CSCO Nov 19 Call for 0.30 and selling a CSCO Nov 20 Call for 0.10 and a net cost of 0.20. The stock is around 18 so a move over about 12% (the average move over the last four quarters) is needed to hit 20.00. At 20.00 per share the spread would be worth around 1.00 for a profit of 0.80. If the stock reaction to earning goes the other direction or it does not rally above 19.00 then the trade results in a loss of 0.20.
Priceline (PCLN – 513.37) reports earnings on Monday and the options are discounting a 9% price move off earnings which is very similar to the average move the stock has experience from earnings the past eight quarters (11%). This trade idea is a bullish one as well, but involves using put options. The recommendation is to sell a put spread using the PCLN Nov 505 Put and PCLN Nov 465 Put. The spread sells the PCLN Nov 505 Put at 31.00 and buys the Nov 465 Put for 16.00 for a net credit of 15.00. This trade makes money as long as the stock is above 489.00 at expiration or about 24 points below where the stock is trading right now. The 15.00 credit received is the maximum potential profit based on the stock closing above 505.00 at expiration. Finally, the maximum potential loss is 25.00 which may occur at any price from 465.00 and lower.
As for me, while the sun is out I’m going to rake leaves and get other outdoor activities under my belt while I can, like the saying goes, the one thing we know about the weather in Chicago is it will always change. Maybe we can start saying that about the situation out of Europe as well.