Anatomy of a Trade – $CRM Call Fly

by CC April 7, 2015 3:30 pm • Commentary

At the beginning of March we looked at Salesforce (CRM) following its late February earnings announcement that saw the stock gap higher above $70 for 2 days, which was quickly followed by a gap fill towards $64. Here’s what we said at the time when the stock was $65.35:

If I were inclined to play for a re-test of last week’s highs around $70 I would probably look to a call butterfly, looking to take advantage of the elevated vol, at least on the out of the money portion of the spread.  I want to give the entry one more day to see if we get a fifth day of follow through. I’d love to see the stock nearer to $64 before putting this on, but gun to my head today this is the trade that I would choose

CRM ($65.35) Buy to Open April 65/70/75 Call Butterfly for 1.20

-Buy 1 April 65 call for 2.90

-Sell 2 April 70 calls at 1.00

-Buy 1 April 75 call for .30

Break-Even on April Expiration:

Profits: up to 3.80 between 66.20 and 73.80 with max gain of 3.80 at 70

Losses: up to 1.20 between 65 and 66.20 & between 73.80 and 75, with max loss of 1.20 (or about 2% of the underlying stock price) below 65 or above 75

Rationale: Decent payout potential if the recent stock selling is simply profit taking and the stock recovers back towards the $70 level. Volatility should also settle if that happens and this would be profitable both on deltas and vega if that’s the case. If the entry is indeed wrong it’s a defined risk bet that alleviated  much of its premium risk with the x2 sale of the 70 calls.

Since then the stock is indeed recovering towards the highs and got as high as 69.75 this morning:

Screen Shot 2015-04-07 at 1.07.24 PM
3 month CRM from LiveVol Pro

With the stock now at $68.50 this trade is worth about 2.50 or more than a double. That’s a nice profit but there’s also a buffer built in at this point as the trade is intrinsically worth 3.50. So you have a dollar or so that will come in before now and April expiration to play with. Your risk appetite should determine what you do next. The theta (decay) on the trade today is about 6c, meaning every day (barring no movement in the stock or changes in implied vol) the trade is worth another 6c. And that picks up into next week.

There is significant delta risk though as the trade is now more than 30 long deltas and that too will grow exponentially into expiration until it’s (+) 100 deltas. So that means the longer you stick around the more this trade is likely to make, but also the more risk you take of the stock selling off.

Luckily the trade is already a double and you can just sell half or all if you have better things to do than contemplate concepts like the Black-Scholes model (this is also an important life lesson). If you sold half here you could take all your risk off the table and just manage the rest looking for a home run (with the stock at 70 this trade is worth $5).

Either way, if you sold half or wanted to ride out the existing double, I’d probably just keep a mental stop in the stock a little lower, maybe as tight as 67.50 and maybe agree with myself to sell at least half if the stock went down to that level. CRM is fairly volatile so there is overnight gap risk. On the upside that also holds true although I can’t imagine the stock gapping right through $70 without a significant news story.