Trade Update July 13th, 2012 at 10:30am: Since buying the GE Aug 19/17 put spread on June 22nd at 0.30, GE has basically gone up, then back down. The stock is trading around where I initially bought the put spread. With the Aug 17 puts trading at 0.05 this morning, I am going to use this rally to buy them back and turn this trade into a long outright put. As I mentioned in this morning’s wrap, I think the market is more volatile than options are pricing in, and I want to give myself more exposure to a big move over the next month, especially with GE’s earnings report next week. 5 cents is a small price to pay for that exposure.
Action: GE (19.81), bought back the Aug 17 puts for 0.05.
Original Trade June 22nd, 2012:
Here is a preview of what I will be discussing tonight on Options Action on CNBC at 5pm:
General Electric is the oldest of global industrial companies. Its main business units range from energy infrastructure, to aviation, to health care, to financial services. More than 50% of its revenues come from outside the U.S., and at a more than $200 billion market cap, it is the largest diversified industrial company in the world.
Much has been made about the global slowdown indicated by global PMI’s, and the Philly Fed number in the U.S. this week at -16 was more evidence that the slowdown was infecting all regions. Industrial commodities like oil and copper have also been acting quite weak, both down substantially this week. Increasingly, the main question mark for this market is not Europe, but rather, are we entering a global recession?
The evidence is piling up in that direction, and stock price action supports it as well. GE though, has shown surprising strength as global markets have deteriorated over the past 3 months. A great illustration of this is comparing CAT vs. GE over the last year:
The 2 stocks had closely tracked each other until mid-April, when CAT started following international markets lower, and GE remained bid. GE is certainly a more diversified company than CAT, but the 2 companies are both basically bets on global growth. In fact, GE made 30% of its total profits in the 1st quarter from its energy infrastructure segment (and 50% of its non-financial unit profits). Oil moving lower should directly impact their future order book in that business, and I anticipate that we get more clarity on that point from them on their earnings report in July.
Finally, volatility looks abnormally low in GE given the cross-market headwinds and even on a standalone basis.
The red is the implied vol which is currently about even with the actual vol in (blue) the stock, it usually tends to be slightly higher. Additionally, the Implied Vol is decently lower from where it historically has traded in the past few years (yellow.)
Here’s the trade:
TRADE: GE ($19.76) Bought the Aug 19 / 17 Put Spread for 0.30
- Bought 1 August 19 put for 0.45
- Sold 1 August 17 put for 0.15
Break-Even on August Expiration:
- Profits between 18.70 and 17.00, make up to 1.70, with max gain of 1.70 below 17.00, down about 14%
- Losses of up to 0.30 between 18.70 and 19.00, with max loss of 0.30 above 19.00
TRADE RATIONALE: This trade structure gives me almost 6 to 1 risk/reward, with about 2 months of time remaining to expiry, illustrating the favorable vol dynamics at play here. It takes advantage of low implied volatility and high skew (the difference in vol between the 19 and 17 strikes is 7 vol points). The stock actually reports the day of Jul expiry, but I chose August because I wanted to give myself more time for the trade to work.