On few weeks ago FedEx (FDX) was set to report Q3 results. We previewed the event and offered a stock alternative based on the idea that a move higher was unlikely to take out new highs while risk to the downside on the event should be defined. Here was the idea and rationale, from March 21st:
Stock Alternative/ Replacement
in lieu of 100 shares of FDX (193) Buy the Apr 192.5/202.5/212.5 call fly for 2.30
- Buy 1 Apr 192.5 call for 6.30
- Sell 2 Apr 202.5 calls at 2.35 (4.70 total)
- Buy 1 Apr 212.5 call for .70
Breakeven on April expiration – Defines risk to just 2.30, much less than the implied move. Gains of up to 7.70, targeting just above the implied move and the all time high. IF the stock goes higher it’s likely to find resistance near the target. If it tanks risk is defined.
The stock didn’t move much following the report and with it slightly higher I wrote this update on March 22nd:
With FDX 194.25 this stock alternative is worth about 2.80. So it’s acting well, similar to stock on about a 50 delta. As we move into April this will approach 100 deltas if the stock is above 192.50. It’s unlikely the stock will gap higher above 202.50 in that time period so the ideal situation is a slow grind higher. On the flipside, if the market selloff we saw yesterday were to follow through, and take stocks like FDX down with it, the risk is still defined, and better than that of stock right here as the most that can be lost is still just 2.80. I still like this position better than stock here, maybe even more so than before the event as its market protected by defined risk in case of a selloff but will have similar gains to stock on the upside.
The stock did decline following that post, getting as low as 191. The important thing is with defined risk, this trade idea could withstand that threat of a breakdown pretty well. Since that move lower the stock has rebounded and then some. and with the stock now 196.50 this trade idea is worth about 3.90. Again, the situation remains the same as far as risk to the upside of the stock ripping through the 202.50 strike, meaning very little. And to the downside the risk is still defined, albeit now with profits at risk as well as the initial premium outlay.
As far as intrinsic vs extrinsic value, there isn’t much difference from the intrinsic value of 4 and the mark to market value 3.90. As we approach expiration the 192.50 calls will lose about 1.40 of extrinsic premium, but the 2x short 202.50 calls will lose more than that, about 1.50. So decay isn’t an issue here either way.
In short, it’s still a well designed stock alternative that will mimic gains and losses similar to the stock from here on out (assuming a range of 192.50 to 202.50). Decisions on trade management in taking profit or protecting against losses should be similar to as if one was long stock. But again, with the added bonus of knowing the most that can be lost on a gap lower remains defined, and therefore easier to remain in the game.