Weekend Review – 11/3/2013

Barron’s –

The striking price column discussed mutual funds this week.  No, the column has not changed its focus.  The discussion was about mutual funds that have an option component to their strategy.  It was noted that covered call strategies can underperform in strong market environments like we are experiencing in 2013.  However, it is also noted that on a risk adjusted basis consistent covered call strategies have strong risk adjusted returns.  One fund that was highlighted is the YCG Enhanced Fund (YCGEX) – they sell options on about 25% of their holdings.  It was noted that the fund sells call options against long positions and will sell put options to enter a new position.

Options Action –

The discussion kicked out with analysis of Apple (AAPL – 520.03) and the new iPad being launched on Friday.  The feeling was that sentiment will be bullish for AAPL into the holidays which results in a recommendation for a bullish call fly with a target price of 550.  Using December options 1 AAPL Dec 525 Call was purchased at 15.00, two 550 Call were sold for 7.00 each and then 1 AAPL 575 Call was bought for 3.00.  The net cost for this trade is 4.00, which is also the maximum loss.  If AAPL is right at 550.00 at expiration then the result will be a profit of 21.00.   As there are several moving parts, a payoff diagram appears below to clear up the risk and reward for this trade.

AAPL PO

The second trade focused on a city I get to visit in a few weeks (Las Vegas) for Trader’s Expo.  The specific stock was Wynn Resorts (WYNN – 167.70) which is trading at 52 week highs and is well above any trend.  Basically the thought is the stock needs to come down a little as it may be ahead of itself.  The trade is long term in nature and uses some time decay to lower the cost of a bearish outlook.  A WYNN Dec 160 Put is sold for 3.50 and the WYNN March 160 Put is purchased for 8.25 and a net cost of 4.75.  The idea is for WYNN to top out, but not start moving below 160.00 until after December options expire.

2 Comments
Russell Rhoads, CFA

CBOE Options Institute

Russell Rhoads, CFA, is a Senior Instructor with the Options Institute at the Chicago Board Options Exchange. He joined the Institute in 2008 after a career as an investment analyst and trader with a variety of firms including Highland Capital Management, Caldwell & Orkin Investment Counsel, TradeLink Securities and…

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  • SBTrades

    The AAPL trade is no better than a 1:1 risk reward trade. The probability of hitting exactly $550 on expiration day is so remote that it should be immediately excluded from consideration. Therefore the expected return given the remote probability of both time and price occurring, the most you could expect as reward for a butterfly (maths excluded from this post comment for obvious reasons) is just over $5. Making this no better than a 50% probability bet.

    Although this is a low capital requirement trade, the probability of this acheiving the Maximum expected return of +$5 is still remote given the low cost and low probability. One also has to take into account that these types of trades will remain worthless for most of the trade duration until the last 2-3 days before expiration whereby the trades can be hit or miss during the final week before expiration.

    Although this trade has low capital requirements it has low probabiltiy and low risk/reward. There are better trades to be considered.

  • http://www.options-trading-training.com casey braman

    Some of the trades that I have performed is not doing very well. I lost money in the market in 2014 and planning to put the discussion in http://www.options-trading-training.com web site as an educational information. Lot of people will not provide their losing recommendations. But I think that provides a great deal of information to the aspiring traders.