Options Strategy: Suncorp-Metway (SUN)

Posted on March 29th, 2010 admin No Comments

The following options trade on SUN take advantage a buy recommendation and a short-term price target of $10.50. The volatility is high after there on the SUN put options and low on the SUN calls meaning a protected long synthetic is a great strategy to take advantage of these volatility levels.

The options strategy has limited risk, and will make money as soon as the share price increases so the position can be closed out at any time for a profit once the share price increases. The trade has limited risk and unlimited return. The greater the share price increases, the higher the profit. Once the stock has moved there could be opportunities to sell short dated options against the position to further increase the return.

The call position expires in April, so there is time for the stock to increase. The trade involves buying a long dated call for June which expires in 6 months to take advantage of the share price increasing. To pay for this we are selling a bull put spread out until June to pay for the call option. The whole trade is actually done for an approximate 18 cent credit or $180.

The trade details are below as well as some more information on the reasons for entering this trade.

Trade:

* Buy 2 contracts April 2010 $8.33 Puts 26 cents

* Sell 2 contracts April 2010 $8.82 Puts 47 cents

* Buy 1 contracts April 2010 $9.31 Calls 24 cents

Net credit: 18 cents

Net credit: $180

Summary:

Maximum Profit: Unlimited

Profit if above $8.82 and below $9.31 = $180 or Return on Risk of 22.5%

Maximum Loss is below $8.33 = $800

Breakeven = $8.64

Primary Profit Target $10.50 = $1,600

Return on Risk = 200%

Secondary Profit Target $12.00 = $2,900

Return on Risk = 362.5%

Margin requirement: This trade is done for a credit of $180; however a margin is required for the bull put spread. The margin requirement will increase if the stock falls, and reduce if the stock increases. After the market increases the bull put spread if cheap enough will be closed out for a profit and then there would be no margin requirement. Allow approximately the maximum risk in dollars to cover the margin requirement or clients with share portfolios can use the shares as collateral. Initially the margin will not be that high, but it’s important to have it available if needed.

If you would like to place this trade please email me your account number and quantity of contracts to trade otherwise I can be contacted by email or on 1300 736 622 for more information.

Trade Summary:

* Fundamentals of SUN are strong after announcing an increase in First Half Net Profit of 41% this morning.

* Volatility is high on the put options and low on the call options so we are selling the high volatility and buying the low volatility to take advantage of this short-term volatility spike.

* A primary Profit Target exists at $10.50. This trade has unlimited return; however around the $10.50 level the trade would be up approximately $1,600 (100% return on risk + a higher return on the funds invested) for the above recommendation.

* A secondary Profit Target exists at $12.00. This trade has unlimited return; however around the $12.00 level the trade would be up approximately $2,900 (181.25% return on risk + a higher return on the funds invested) for the above recommendation.

* Notice on the chart below that SUN is still in a very strong uptrend.

* This trade has limited risk and unlimited return and provides leverages exposure to SUN break out above the recent highs of $9.40.

* The position can be closed out at any time once the share price has increased. This trade does not have a neutral trade and therefore does not need to be held until expiry to achieve maximum profit.

* On the monthly chart it shows a bull flag which is an explosive breakout pattern which would help SUN reach its targets in the short-term.

The Strategy – Protected Long Synthetic:

The Protected Long Synthetic is a strategy designed to have a leveraged exposure to a stock while only committing a small amount of capital. The strategy is designed to have a bullish view on a stock and to determine the maximum risk when entering and having unlimited potential return. This strategy is implemented when a stock looks set for a breakout or a strong share price increase. The bull put spread is entered for a credit and the funds received on this trade are used to buy call options. Buy selling the put options it reduces the negative time decay on the call options. The strategy also allows a profit to be made straight away and the trade can be closed out early with a profit and does not need to be held until expiry.

For more information on this strategy or to implement a Protected Long Synthetic Portfolio on a number of stocks please contact me to discuss in more detail.

Fundamental Analysis:

This morning Suncorp announced their First Half Results. The market has reacted negatively due to a reduction of the dividend from 20 cents last year to 15 cents. The net profit for the six months to Dec. 31 rose 41% on year to A$364 million from A$258 million a year earlier. So I believe the fall in Suncorp today is an overreaction and recommend buying the stock and the placing this trade.

The result was in the middle of its guidance range, issued earlier this month, for a net profit of A$355 million-A$375 million. The improved result reflected a strong contribution from the group’s general insurance operations, which benefited from favorable weather conditions and improved equity markets during the half. But its banking arm weighed down the result, recording a A$4 million profit for the half. Chief Executive Patrick Snowball, who took up the top role on Sept. 1, said in a statement that while the increased profit was pleasing, the group will maintain a cautious and conservative approach. Brisbane-based Suncorp declared an interim dividend of 15 cents a share, down from to 20 cents last year, which is slightly below its target payout ratio of 50%-60% of earnings.

Weekly Chart:

Monthly Chart:

Payoff Diagram:

To receive ASX Option Recommendations or to learn more about trading options please contact us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Trade Example

Posted on March 19th, 2010 admin No Comments

This is a past recommendation on PBL which demonstrates how the bull put spread strategy works in real life.

Trade:

Bull Put Spread

Sell 10 PBL39 Oct 1950 Puts @ 22

Buy 10 PBL36 Oct 1900 Puts @ 12

Net Credit = 10 cents

This trade requires minimal margin requirements.

Maximum Profit

The ideal result is for both options to expire worthless, so that maximum premium is retained from the credit spread.

= Net Premium Received

= Sold Put Premium – Bought Put Premium

= (0.22 – 0.12) x 10 contracts

= $1000

Maximum Loss

This will occur if the share price is below the bought at expiry

= Difference between strike prices less net premium received

= 50 – 10

= 40

= 0.40 x 10 Contracts

= $4000

Breakeven

Upper strike less net premium received

= 19.50 – 0.10

= 19.40

Main Benefits of Strategy

1. Provides leveraged exposure to a rise in the share price

2. Takes advantage of time decay

3. The ideal result is for the options to expire worthless, which means the client will save on brokerage not having to close the position to take a profit.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

What Strategy to Trade?

Posted on March 18th, 2010 admin No Comments

Bull Call Spread
The primary reason for buying a bull call spread is an expected increase in share price. This is a directional trade and the aim should be a high percentage return. The reason for placing a bull call spread is that the calls are expensive so sell an out-of-the-money call will reduce the cost of the trade. This strategy is suited for break out trades and trading trends.

Bear Put Spread
The main reason for buying a bear put spread is an expected decrease in share price. The aim of the directional is to have a high risk vs. reward ratio. The bear put spread can be traded when buying puts is too expensive due to high volatility and selling an options against the bought puts reduces cost, breakeven, volatility effect and time decay effect. The trade is suited to a share price in a downtrend. This strategy is suited for break out trades and trading trends.

Bear Call Spread
A bear call is traded when you are expecting a sideways share price movement to a slight decrease in share price. The bear call spread is a credit spread and can be traded as a type for income. The risk vs. reward can be set up depending on the aim of the trader whether to have high probability small profits or low probability high returns. This trade is suitable when volatility is high and expected to decrease. The bear call spread is traded to take advantage of time decay.

Bull Put Spread
A bull put spread is best suited for a sideways to upward trending share price. The bull put spread is a credit spread and can be used as an income generating strategy. The bull put spread is best implemented when there is high volatility in the puts your outlook is volatility to decrease. This may be because the share price is just above a major level of support or at the bottom end of a trading range. The bull put strategy is traded to take advantage of time decay.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread vs. Sold Put

Posted on March 18th, 2010 admin No Comments

A number of advantages are evident when trading bull put spreads compared to selling puts (naked puts). A bull put spread has considerable lower risk than just selling a put which has a much larger risk. The bull put spread has a much better risk vs. reward than selling naked puts. Selling puts can have benefits when combined with portfolios that can help produce income and purchase stock below market value. This strategy is detailed in the Income Strategy E-Book and will be available later in the course.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Strategy Risks

Posted on March 17th, 2010 admin No Comments

It is important to always be aware of the strategy risks. The primary risk when placing a bull put spread is when the share price decreases past the sold put and an ever greater concern is if the share price decreases below the bought put (protection). Since you receive a premium to enter this trade there is a required margin. This margin can increase to as much as 1.2 times your maximum loss. For example if you were risk $2,000 the cash margin required in the account can increase to $2,400 (2000 *1.2) which includes the premium received. So it is important to know your maximum risk and make sure there are enough funds to cover the worst case scenario.

Another risk inherent with selling options is volatility. When you open the bull put spread you want the volatility to be high so you can sell the put options for as much value as possible. Once the trade is placed you want the volatility to drop off and time decay to kick in. So even if the share price stays still but volatility increases the position may not profit in the short-term. Increased levels in volatility mean to close out it will cost more to buy back the sold put. If the share price decreases below the sold put prior to expiry there is potentially a risk of exercise.

Exercise

The main risk of credit spreads is the risk of being exercised. If the sold put is exercised it means that you are obligated to buy shares at the exercise price of the sold put. This can have a negative impact in terms of you have bought shares you do not own which means you need to sell them back at the lower level and therefore locking in a loss on the share position. If the share price is below the bought put (protection) when exercised then you can sell the put option which will reduce the loss from being exercised. It is still not possible to lose more than the maximum risk before entering the trade. Another disadvantage of being exercised is the brokerage on the share purchase and sale so it is a good idea to try an avoid exercise. To avoid being exercised you need to monitor your position and more importantly the delta on the sold put. If the share price is below the sold put an indication of the likelihood of being exercised can be identified by the delta. If the delta on the sold call is below -0.95 there is a chance being exercised. If the delta is below -0.98 then it is necessary to implement one of your exit strategies.

To avoid exercise there are two options. If you think the share price will keep decreasing you can close the trade for a loss. If you think you view is correct and the share price will rise from this level and want to keep the position you can roll out to the next month. What this means is you can close the positions you have an open the same position for the next month and do this for no cost or a small credit. Therefore if the share price then increases above the sold put by the next month you can still make maximum profit.

To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Trade Analysis – Risk vs. Reward

Posted on March 17th, 2010 admin No Comments

Trade Analysis

Analysing your trade is essential before placing the trade. You need to make sure you have the necessary detail and go through the following checklist:

  1. Stock Selection: Double check your analysis on the stock and make sure your outlook on the share price reflects the bull put spread.
  2. Determine max loss and check that that is suits your risk profile and how much of your trading account you are risking.
  3. Determine premium received when entering trade, most important as it is also your maximum profit.
  4. Make sure you risk vs. reward suits the trading strategy.

Risk vs. Reward

The risk vs. reward will be different for every strategy. Credit spreads have a lower risk reward meaning the maximum profit (reward) is quite low relative to the maximum loss (risk). This trade can be positioned to risk $0.50 to make a $0.50 this is when the bull put spread is traded at-the-money. The trade can be more cautious by selling out-of the money options where you risk $0.80 to make $0.20. Both trades work well at the right time but the first example only requires a 50% success rate to break even while the second example requires an 80% success rate to break even.

Author: Matthew Gartrell

To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Technical and Fundamental Analysis

Posted on March 17th, 2010 admin No Comments

Technical Analysis

Identifying bull put spread can be assisted through technical analysis. Technical analysis allows identification of expected price movement through indentifying trends through momentum indicators and trend lines. The types of chart patterns you are looking to identify a bull put trade are:

  • Strong support levels
  • Uptrend
  • Lower end of trading range
  • Oversold indicators – MACD and Stochastic.

Fundamental Analysis

Fundamental analysis can determine if the bull put outlook is aligned with the company news and research. There are a number of fundamental factors that influence the option prices of a stock. When identifying a bull put spread you have a bullish to neutral outlook on the share. Therefore you are looking for positive news in the company or sector. As this trade also makes money if the share price does not move, if there is no news coming out of the company for the next month this can also be a positive for this particular strategy.

To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Advantages and Disadvantages

Posted on March 16th, 2010 admin No Comments

Advantages of Bear Put Spread

  • The loss is limited if the underlying share price falls instead of rises.
  • If the share price fails to stay above the strike price of the sold put option, the profit yield will be greater than just buying call options.
  • Able to profit even when the share price remains completely still.
  • Lower risk than simply writing naked put options as maximum downside is limited by bought put option.

Disadvantages of Bull Put Spread

  • There will be no more profits possible if the underlying asset rises beyond the strike price of the sold put option.
  • Because it is a credit spread, there is a margin requirement in order to place the trade.
  • As long as the sold put options remain in-the-money, there is a possibility of it being assigned. You may then have to purchase the underlying stock to meet the sold put obligation.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Identifying Trades – The Greeks

Posted on March 16th, 2010 admin No Comments

Delta

When identifying trades it is essential to look at the delta of the option legs. In particular it is important to calculate the net delta of the bull put spread. The net delta is calculated by the delta of the sold put option minus the delta of the bought put option. The net delta will always be negative. The net delta indicates if the share price increases quickly what the value of the bull put spread will be worth. For example, if a bull call spread had a net delta of -0.20, and the share price decreased by $1.00, the bull put spread would have decreased by 20 cents. Therefore to close out the position you buy back the position for less than the premium received to enter the trade.

 

Vega

The volatility affect on a bull put spread is positive. When looking to enter a bull put spread you look to sell an out-of-the-money put option. The idea is to sell a put option which has a relatively high volatility and therefore trading above its theoretical value. The bought put even further out-of-the-money and you want to buy this option with low volatility. When entering the trade you want to volatility to be high and decrease throughout the trade.

 

Theta

Credit spreads are set up to take advantage of time decay. The effect of time decay on this strategy varied with the underlying share price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the higher strike price of the sold put, profits generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the lower strike price of the bought put, losses generally increase at a faster rate as time passes.


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bull Put Spread: Option Pay-Off Diagram

Posted on March 12th, 2010 admin No Comments

It is essential to understand the option pay-off diagram for the option strategy you are trading. It allows you to know to determine at what share price you achieve maximum profit, maximum loss and breakeven level at expiry. The bull put spread is made up of a sold put and a bought put at a lower strike. When combined it creates a bear put spread. See below for how the bull put spread option pay-off diagram is constructed. The dotted green line is the sold put and the dashed green line represents the bought put.

Bought Put


Sold Put


Bull Put Spread


To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au