Prior to Micron’s (MU) March 22nd earnings events we detailed a couple of bearish trade ideas, one outright, and one as a hedge versus stock (here: March 21st) Both worked out well as the outright bearish expired at a 4.21 value versus the initial $1 at risk and the hedge saved a good portion of the downside move in the stock. In early April we recapped both trades and detailed a move in options for those long the stock to book the hedge “profits” and inexpensively re-position to get some money back if the stock bounced. Here’s what we said, from April 6th:
For those looking to book this hedge soon and play for a rebound, one way to do that is with a ratio call spread. Right now the May 50/55 1×2 call spread costs about .30. What that means is if MU were to bounce between now and May it would be like owning 2x the stock (assuming 1 to 100 shares) between 50.30 and 55. If the stock were to bounce back above 55 you are called away in the stock, but at an effective sale price of 59.70. That’s pretty close to to where the initial hedge was initiated. And the amazing thing is if the stock were to bounce back to 55, between booking $5.30 on the hedge then the opportunity to add up to 4.70 on a bounce, It would be as if you added $10 in profits in the stock.
I love this tactic in a stock holding that has just had a precipitous decline. It of course does nothing for you if the stock continues to fall, but if the stock bounces, you gain leverage and you add only a tiny bit of extra risk (in this case 0.30).
With NU now bouncing a bit let’s check back in on this stock overlay. MU is currently 52.45 and the May 50/55 1×2 call spread that initially cost .30 is now worth 1.90. That’s 1.60 in additional gains on this move higher and when added to the initial profits on the hedge has saved about $7 versus the 8.50 decline in the stock (the initial hedge was detailed when the stock was 61). What’s also great about the hedge and then the switch to leverage the initial hedge was even money and the leverage was .30. The only real “risk” on both trades was the chance of being called away higher in the stock.
As far as trade management goes, the intrinsic value of this trade is currently 2.45, it can be worth up to $5 at or above $55 next Friday, and it of course can be worth zero if the stock fails and closes below $50 next Friday. So conviction level is probably the most important factor here as far as taking the trade off for profits or letting it ride a bit more in hopes the stock is here or above over the next week.