Weekend Review

Barron’s –

Steven Sosnick from Timber Hill took over the Striking Price column this week and discussed one of my favorite market topics – Earnings Season.  He mentions that to the casual observer earnings trades may seem similar to playing a casino game.  However, he points out there is a relatively ‘conservative’ script that companies may follow four times a year when reporting earnings.   Before jumping into the pattern around earnings, he does mention the best way to play earnings is to have a price outlook for the stock and then back into the best option trade.  He is preaching to the choir on this one to me, in fact I think those words ring true for any option trade.   The pattern around earnings is typically excessive fear priced into options then followed by a drop off in this fear and much lower implied volatility levels.  Various spreads, depending on the price outlook for the underlying can mitigate the risk around a drop in implied volatility.

Options Action –

The guys started out discussing earnings season and the feeling was that because valuations are a bit stretched it will take a slew of good news for earnings to push stocks to much higher levels.  It was noted that much of the stock market’s performance has come from more defensive stocks.  Both of those factors had the panel sounding a bit bearish.

The first recommendation was the very straightforward bearish put purchase on Johnson & Johnson (JNJ – 82.74).  The company does report earnings next week, but this is more of an overvaluation trade than an earnings play.  The trade was put on when the stock was trading just a little lower than the closing price the JNJ May 82.50 Put was bought for 1.35.  The break even on this trade is 81.15 and profits are made below that level if held to May expiration.  The question was posed why not trade a spread to offset some premium and the answer had to do with the low volatility environment and that option premiums are low enough that there is not much of a need to offset option costs.

Long 1 JNJ May 82.50 Put @ 1.35

JNJ po

The second trade was on one of my favorite places Chipotle (CMG – 341.91) and a bullish one as CMG has underperformed other casual dining stocks.  The idea is to sell a put spread taking in premium that will be equal to the best potential profit of the trade.  Looking out to June the CMG June 330 Put 14.80 is sold for and the CMG Jun 325 Put is bought at 13.00 for a net credit of 1.80.  The net result is a trade that can profit 1.80 if the stock is over 330 at expiration and a maximum loss of 3.20 if CMG is under 325.00 at expiration.

CMG Jun 325 / 330 Bull Put Spread @ 1.80

CMG po

Finally there was a mention of mini options and specifically and idea around trading Apple (AAPL –429.80) using these new contracts that represent 10 shares as opposed to the standard contracts that represent 100 shares.   The options action web extra feature talks all about them –