Friday on Options Action we reviewed a trade suggestion from early March to Buy Bullish April Call Spreads in GLD, that I made on the program (3:40 into the video here) and on RiskReversal (here)
Trade From Mar 1, 2011:
TRADE: GLD (~139.25) BUY APR 140 / 148 CALL SPREAD for ~$2.00 or ~1.5% of the underlying
-Buy 1 APR 140 CALL for 2.75 and
-Sell 1 APR 148 CALL at .75
Trade Review From April 8th:
-This Spread at one point on Friday could be sold for about $4.00. My take: With 5 trading days left to expiration you are risking almost 4 to make about 4, which isn’t exactly a great risk / reward proposition over such a short period of time.
–At this point I want to roll that Apr call spread into something a bit farther out, possibly to June as I suggested last week on the site and Friday on Options Action. The GLD breakout has been powerful and could have more to go, but again I want to define my risk as the etf/stock has routinely sold off about 5% on its failed attempts through this 140 level dating back to last fall.
-This weekend, Barron’s Striking Price Column (here) echoed a similar view by derivatives strategist Jim Strugger of MKM Partners. He suggested putting on a Risk Reversal to gain Long exposure by selling the June 135 Put and Buying the June 150 Call…the article didn’t give any prices, but for comparison, at Friday’s close that would have cost you ~.65 making your break-even on the upside (on June expiration) at 150.65 (up ~ 5% from current price of 143.66) and leaving you exposed to buying the stock on June expiration at 135 (down ~6% including the premium outlay).
MY VIEW ON THIS TRADE: Strugger and I are in agreement here on positioning as it relates to direction and timing, and if you are initiating a new position in the name, this is a highly aggressive way to do it. You don’t really take on anymore risk at expiration, but if the stock were to move sharply lower you would be exposed to mark to market losses with the stock above 135, which would include a spike in downside volatility and the additional risk of being Put the stock at 135 on June Expiration. I am often a fan of this trade structure, and more often than not, I employ it when I find a very favorable opportunity to take advantage of skew between the downside puts and the upside calls, but since I am rolling a previous position from a point with the ETF lower, I had a different trade in mind.
-Because of the trade structure that I am rolling from, I want to continue to define my risk through owning call spreads, especially when you consider that the stock is almost 5% higher than when I first put on the trade and I don’t exactly want to swap into a riskier trade.
-Even-though the stars seem to be aligned for Gold to continue its momentous run, remember this is a very crowded trade, as evidenced by Q4 13f filings released last month that showed the continued accumulation of the ETF by very large institutional players at all time highs. A few things, including the mere positive price action, increased concentration by holders due to appreciation, increased speculative buying and hedging only add to the potential for volatility if there is any reason to take profits……THIS IS THE REASON WHY I PREFER A TRADE STRUCTURES THAT DEFINES MY RISK.
NEW TRADE:
GLD (stock ref 143.66): BUY June Qrtly 145 / 151 Call Spread for ~2.00
-Buy Jun qrtly 145 call for ~3.60 and
-Sell Jun qrtly 151 call at ~1.60
Break-Even On June 30th Expiration:
Losing Scenarios: Stock btwn 145 (up ~ 1%) and 147 (up ~2%) lose up to 2.00,
Worst Case: stock below 145 lose all 2.00,
Winning Scenarios: stock btwn 147 and 151 make up to 4.00,
Best Case: stock above 151 make 4.00.
TRADE RATIONALE: I want to look out to The June quarterly expiration as that will incorporate the June 22 FOMC meeting which will very likely detail further easing measures or finally put to rest a potentially very damaging policy. Much of this will be anticipated in the markets by this point, but after the APR 27 meeting there will be one of the longest periods of the year without such a meeting and speculation will run wild. Much like this past week’s action, you will not want to miss the move when it happens, so you want to leave yourself some time around potential catalysts.
-As for the Call Spread vs an outright call purchase I think you want to give yourself the best odds of success to capture further upside. The idea of buying that June qrtly 145 call for 3.60 and needing a $5.00 move to break-even doesn’t sit that well in my stomach. I am willing to draw a line in the sand and say that if I can risk 2 to make 4 and relinquish the unlimited upside, but know that I defined my risk and lowered my break-even to up 2%, rather than up 5%. then I am happy sit with the higher probability trade.