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Weekend Review by Russell Rhoads, CFA

by rrhoads on 01-07-2012 10:04 AM

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. 

    

 

Barrons –

 

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. 

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Comments
by adinfinite on 01-08-2012 04:24 PM
Options

Good review but i was hoping to see something about Europe in all this. Do you notice that the market seems to drop or go mostly sideways ( in a choppy fashion) from the open @ 9:30am ET to when the European market closes around mid-day ET?? This has certainly been the case over the last week. It wasn't such a bad week though as i was able to make a few good trades based on recommendations from NO and WOT ( which seems to be good at the weekly options thing). 

 

Finally, your JPM trade looks good and i will attempt it but i will leave AA alone. I believe that there will be better opportunities once earnings season really gets going next week. Apart from AA and JPM there isn't much in terms of earnings plays this week. At least not high beta ones. 

 

Anyway, i'm glad to see the CBOE website finally engaging its audience/readership/users. I look forward to reading more blogs and seeing more discussion and comments here. 

 

Adinfinite

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by rrhoads on 01-09-2012 02:47 PM
Options

Thanks for the comment - not much was discussed about Europe in what I read and it seems to be par for the course over there. 

 

Just as a clarification, these are recommendations from Options Action and Barrons but I found them interesting enough to put up here!

 

 

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About the Author
  • Mr. Bittman is the author of two books, Options for the Stock Investor, (McGraw-Hill, 1996), and Trading Index Options (McGraw-Hill, 1998). He teaches courses for public and institutional investors, and he has presented several custom courses throughout the U.S., Europe, South America and Southeast Asia. In 1980 Mr. Bittman began his trading career as an equity options market maker at the Chicago Board Options Exchange. From 1983 to 1993, he was a Commodity Options Member of the Chicago Board of Trade where he traded options on financial futures and agricultural futures. Mr. Bittman received a BA, magna cum laude, from Amherst College in 1972 and an MBA from Harvard University in 1974. In addition to his responsibilities at The Options Institute, Mr. Bittman is also a member of the faculty of The Illinois Institute of Technology, where he teaches in the masters level Financial Markets and Trading Program.
  • Mr. Kearney began his long association with the CBOE when he became an independent Market Maker in early 1981. Mr. Kearney traded options full time on the trading floor until 1992 and periodically thereafter until 1996. In early 1992 he became a founding partner and Registered Options Principal of a brokerage firm based in Chicago, a member firm of the CBOE. Mr. Kearney’s responsibilities included development and implementation of hedging and trading strategies using listed options for their institutional clients as well as their retail investors. Mr. Kearney is the co-author of Understanding LEAPS®, published by McGraw-Hill, September 2002. He has been a regular contributor to many news services including Reuters, Derivatives Week, BARRON’S, CNBC, Bloomberg, Group W, The CBS Radio Network, FORTUNE, Ticker Magazine, Stock Futures and Options, BBC TV and Radio, NPR, and others. Mr. Kearney served on various committees at the CBOE, including the Arbitration Committee from 1984 to 1996. Prior to joining the CBOE Mr. Kearney was a marketing director for NCR Corporation. Mr. Kearney is a graduate of St. Mary’s University (MN), BS, 1971, and pursued his MBA at Lake Forest Graduate School of Management. In 2006 he completed a 3-year SII/SIA program at the Wharton School of the University of Pennsylvania.
  • Peter B. Lusk is an instructor at the Options Institute, the educational arm of the Chicago Board Options Exchange. He teaches option courses for public and institutional traders and has contributed educational type articles to various financial publications. Peter has spoken to thousands of investors across North America the past few years including over 200 webinars for the CBOE and member firms on trading options. He can also be seen each week on CBOE-TV with his show, Strategy of the Week. In addition to his responsibilities at the Options Institute, Peter serves as an Instructor for the Options Industry Council – an organization representing the options industry in the U.S. Prior to working at the Options Institute, Peter was a highly successful market maker for many years on the floor of the CBOE trading equity options. He was also involved in options training for new market makers at Lakota Trading in Chicago. As a professional trader, Peter enjoys sharing his knowledge of proven option strategies and risk management at the Options Institute.
  • Russell Rhoads, CFA, is an 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 Millenium Management. He is a financial author and editor having contributed to multiple magazines and edited several books for Wiley publishing. In 2008 he wrote Candlestick Charting For Dummies. Since joining the Options Institute he authored Option Spread Trading: A Comprehensive Guide to Strategies and Tactics which was released in January 2011 and recently finished work on Trading VIX Derivatives: Trading and Hedging Strategies Using VIX Futures, Options, and Exchange Traded Notes which was published in August 2011. In addition to his duties for the CBOE, he instructs a graduate level options course at the University of Illinois – Chicago and acts as an instructor for the Options Industry Council. He is a double graduate of the University of Memphis with a BBA ('92) and an MS ('94) in Finance and also received a Master's Certificate in Financial Engineering from the Illinois Institute of Technology in 2003.
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