A quick review of some option centric information that came about between Friday’s close and Monday’s open –
The Striking Price column discusses a new study by Goldman Sachs on the covered call strategy. The study discusses a new approach to using covered calls on a consistent basis. However, the Goldman Sachs method avoids selling call options when a company is preparing to release their earnings. In other words, this strategy or only implements covered call between earnings reports. Using this twist to a consistent covered call strategy from 1996 to 2011 resulted in over 5% outperformance of the S&P 500 while reducing portfolio risk.
Options Action –
As we are on the tail end of the first earnings season for 2012 several of the recommendations over the past couple of weeks have been earnings related plays. The first trade is another one of these short term trades and is on Green Mountain Coffee Roasters (GMCR – 52.50). GMCR reports earnings on Wednesday. The idea here is to take advantage of the magnitude of price movement off earnings. This stock has moved an average of 22% on their earnings report the last eight quarters. Yes, 22%. As of Friday the options are implying a move of 14%. The recommended trade is a calendar spread using the weekly options that will expire Friday February 3rd combined with standard expiration March options. The idea is to sell the GMCR Feb 3rd 60 Call for 1.35 and buy the GMCR Mar 60 Call for 3.05. The net cost of this trade is 1.70 which is also the maximum potential loss. If the market is correct in the magnitude of movement off earnings is bullish this would put the stock very close to the strike price of the options in this spread. A 14% move takes GMCR to 60.00 a share where the weekly GMCR Feb 60 Call would have very little time value, while the GMCR Mar 60 Call would benefit from the price increase in GMCR and still have a few weeks of time value remaining. As a final note, the suggestion was not to rush in first thing Monday morning and put this trade on, but to wait until closer to the earnings release date on Wednesday.
The second trade is on Amazon (AMZN – 197.37) and is based on getting ahead of their earnings report that comes out a week from Tuesday. The outlook for AMZN is bearish over the long term and the expectation is this will be reflected in the stock’s reaction to the earnings report. The recommendation is a pretty bearish put spread, I say pretty bearish because of the strike prices chosen. The trade purchases the AMZN Feb 185 Put at 4.70 and sells the AMZN Feb 0.80 Put at 0.80 for a net cost of 3.90. The breakeven level at expiration is 181.10 and the maximum profit on this trade is 16.10 if the stock trades down to 165.00 at February expiration. Finally, the maximum loss is limited to the premium paid for the trade, 3.90.