If you like a stock, there is a much better way to make money on it other than buying shares. The answer is to use options, of course. Today I would like to share one simple trade you can make as an alternative to owning the stock. It should gain over 50% in two months even if the stock does not go up by a penny. If the stock falls by 10% over that period, you should make about 20%. Meanwhile, people who bought the stock would have absolutely nothing to show for their investment (except maybe a loss).
Why would you ever buy a share of stock when options could deliver these kinds of returns?
An Interesting Options Play for Green Mountain Coffee Roasters
Green Mountain Coffee Roasters (GMCR) has had a rocky year, but for the last few months it seems to have stabilized and might be worth a second look (especially if you could make 20% or more on it with options in just two months as I propose here). First, check out a recent Seeking Alpha article Green Mountain: Stock Is A Good Brew. It might give you a little confidence in the stock.
In the interests of presenting both sides, check out the downside case, also at Seeking Alpha – Stay Away From Green Mountain Coffee. However, even this critic advises against shorting the stock.
GMCR is selling at 9x or 10x earnings and doesn’t appear likely to have a big sell-off in the near future. One option investor recently made a huge options bet that the stock will move higher – see Bulls Smell the Coffee at Green Mountain. These options could return $5 million to the buyer if the stock is above $30 when the November options expire on the 17th.
The option strategy I suggest should make about 20% in two months even if GMCR falls by 10% over that time period.
I have watched this company for many years. It is located in my home state of Vermont. I used to play tennis with its founder, Bob Stiller, every week. (I don’t want to brag, but I remember that I won about 90% of the matches – he seemed to be more interested in growing his company than staying in tennis shape.) Just today, Bob donated $10 million to Champlain College, a local business school that has also been one of my favorite charities (and where I was a trustee for 11 years).
Here is what the risk profile graph looks like for the stock (currently trading at just under $24). These positions cost about $2700 to put on:
The graph shows that a nice profit averaging over 30% can be made in two months at any ending price on December 21st which is higher than $22, and a profit of some sort at any price higher than $20.50. This downside break-even point would mean that the stock fell by 14% from its current level.
Here are the actual positions that create the above risk profile graph:
I used 10 diagonal call spreads, buying January 2013 calls and selling December 23 calls for about $2.70 ($270 per spread). This simple trade is far superior to owning the stock as far as I am concerned. If the stock falls 10%, you still make about 20% on your investment. If the stock stays exactly where it is on January 18th you should earn almost 60% on your money.
Why would anyone buy the stock when they could place a simple spread like this and make money even if the stock goes nowhere or even falls by as much as 10%? It just doesn’t make sense to me.
Any questions? I would love to hear from you by email (firstname.lastname@example.org), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.
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