Posted on March 29th, 2010 
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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:
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