Options Action –
The show started out reviewing the week. It was noted that the market gapped up strong the first trading day of the year (Tuesday) and then was in a holding pattern the next three days. The feeling was this price action may show the market is waiting for 4th quarter earnings results which start to trickle in this coming week. The first Dow Jones Industrial Average component to report is traditionally Alcoa (AA – 9.16) and AA reports their earnings after the market closes on Monday. On Friday JP Morgan Chase (JPM – 35.36) will release their results. These two reports along with the stock market’s reaction should provide some insight into business conditions in the fourth quarter. These are also the two stocks that are used for trading recommendations on the show this week.
The first trade recommendation is a bearish one on JPM and based on the stock dropping on their earnings release Friday morning. Since this is a short term trade, using weekly options that expire this Friday is suggested. Bearing a bearish trade, a bear put spread is the structure of the trade. Specifically, the trade is to buy the JPM Jan 13th 35 Put at 0.60 and sell the JPM Jan 13th 33 Put at 0.15 for a net cost of 0.45. This trade breaks even if JPM is at 34.55 post earning and has a maximum profit of 1.55 (based on a 0.45 cost) if the stock is at 33.00 or lower. Finally, the maximum loss is the 0.45 paid to initiate the trade and this occurs if the stock is at 35.00 or higher upon expiration.
The next trade discussed was on AA and is based on trying to get long for earnings. This trade is a little more complex in the form of a risk reversal. This trade sells a AA Feb 8 Put at 0.15 and buys a Feb 10 Call for 0.20. The net result is a cost of 0.05, the obligation to buy shares at 8.00 and the right to buy shares at 10.00. The risk is a dramatic drop in the share price and having to own shares at 8.00. On the upside, if the stock rallies based on earnings, you have the right to buy shares at 10.00 between now and February expiration.
In an interesting coincidence there’s a bullish article by Andrew Bary on Alcoa stock. One analyst cites a price target for shares of 13.00 over the next 12 months. A price level that caught my eye was that the tangible book value for the stock is 8.00 – the same strike price as the short put in the Options Action recommendation.
The Striking Price column discusses the VIX and using it as an indication of options being cheap or expensive. It was noted that the VIX is at a relatively low level (relative to the past few months) as earnings season approaches.