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A $40 Option Bet on Nike (Including Commissions)

I would like to tell you about an option trade I made today and share my thinking process that went into it. I figure it has an extremely low risk of losing and it could easily double or triple your investment (after paying the commissions). The investment amount per contract is quite low and it is mathematically impossible to lose all of your bet. You will only have to wait two or three weeks to learn the outcome. It involves one of my favorite stocks, Nike (NKE).

Terry

A $40 Option Bet on Nike (Including Commissions)

First, an update on my last two trade recommendations. Two weeks ago, I suggested a trade that would make 66% after commissions if Facebook (FB) closed at any price above $97.50 on March 18, 2016. FB has now recovered and is about $107 and the spread looks like it will be a sure winner. All you have to do is wait out the remaining 3 weeks (no closing trade will be necessary as long as the stock is at any price above $97.50)

Six days ago I suggested a similar trade on Costco (COST) when it was trading at $147.20. This one would make 40% after commissions if COST finishes at any price above $145 in 3 weeks from tomorrow (March 18th). It is now trading near $154. This one also looks like a sure winner.

My suggestion today is quite a bit different from the last two trades because this time around, you can’t determine in advance what the maximum gain might be. This spread also requires you to make a closing trade at some point in the next 2 or 3 weeks rather than just letting the options expire worthless.

Today while I was perusing the market as I do every day, most stocks as well as the Dow and S&P 500 were down slightly on the day, but I noticed that NKE had gained over $.50. For some reason, it was doing better than most of the other companies I watch. Usually when that happens, when the market turns around and edges higher, NKE can be expected to do even better.

NKE announces earnings after the close on Thursday, March 17, St. Patrick’s Day.
Usually, in the weeks running up to an earnings announcement, and particularly in the few days before the announcement, option prices (both puts and calls) get quite expensive as the market anticipates the possibility of a big stock price move once the numbers are made public. As anyone who plays the market knows, big price moves quite often occur right after the announcement.

Option prices are considered high or low depending on their Implied Volatility (IV). When greater volatility (such as directly after an earnings announcement) is expected in the stock, IV for the options often soars, especially for the weekly series which expires just after the announcement. When I checked IV for the NKE Mar-16 options (which expire on Friday, the day after the announcement), I noticed that IV was 29, exactly the same as it was for the Mar2-16 and Mar4-16 series which expire in the weeks before and after the Mar-16 series. This is a most unusual situation. Surely, sometime in the next two weeks, IV for the Mar-16 series will move higher than the other weekly series.

When I placed my trade, NKE was just about $61. I expect that in the next two weeks, it is likely to move higher, both because of today’s unusual strength, and because more than half the time, stocks move higher just before expiration day in anticipation of good news coming along.

I made the following trade (per contract):

Buy To Open 1 NKE Mar-16 63 call (NKE160318C63)
Sell To Open 1 NKE Mar2-16 63 call (NKE160311C63) for a debit of $.33 (buying a calendar)

Each spread cost $33 plus a commission of $2.50, or $35.50 (actually less than the $40 I advertised at the beginning). Thinkorswim charges Terry’s Tips subscribers $1.25 for a single options contract. Many people become subscribers just to get this lower rate – their savings often pay for the entire subscription price. Your broker may charge more for a single option trade and you may have to buy 10 or more contracts to gain a more reasonable average commission rate.

So what am I hoping for? I expect NKE to move higher and my Mar-16 call to move up more than the Mar2-16 call I sold. Most of all, I would like the price of NKE to move up just a bit so that on Friday, March 11, it is trading at just under $63. When you buy a calendar spread, you always hope the stock ends up at exactly the strike price when the short side expires. If the stock is just under $63 on that day, the Mar2-16 call will expire worthless, and I will end up with a Mar-16 63 call with one week of remaining life.

I expect that IV for my long option will move much higher than 29, and that on the prior Friday, that option is quite likely to be much higher than the $35.50 I have invested in each calendar spread. I will probably sell as many of the options I need to in order to get back my entire original investment so I can’t possible lose anything and I still hold a mini lottery ticket.

I will hang on to my remaining long options, hoping that the stock moves even higher in the days leading up to Thursday, and IV continues to grow. I might then sell most of my calls on Thursday and leave a few remaining, hoping for a windfall gain if the stock does manage to move higher after the announcement. Since those options expire on Friday, I will have to sell them on that day (I have no interest in exercising them and putting up all the necessary money to own stock).

So you can see I expect to have some fun with this trade. You might want to do 10 contracts and risk $355 so that you have some flexibility on how you exit the positions. Since your long options have a longer lifespan than the calls you sold, they will always have at least some additional value so that you could never lose all of your investment.

If the stock is above $63 on March 11 when the Mar2-16 calls expire, you would either sell the calendar spread or buy back the expiring calls, thus increasing your investment and risk, or do some combination of the two.

 

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