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An Interesting Short-Term Play on Aetna (AET)

Wednesday, January 11th, 2017

We are always on the lookout for unusual option prices that might indicate a better-than-usual investment opportunity.  I would like to share one of those recent opportunities with you, one I personally acted on and passed on to Terry’s Tips  subscribers last Saturday.  It involves the venerable insurance company, Aetna.

Terry

 An Interesting Short-Term Play on Aetna (AET)

 This week, we are looking at Aetna (AET), a health care benefits company.  If you check out its chart, you can see that it does not historically make big moves in either direction, especially down:

AET Aetna Chart January 2017

AET Aetna Chart January 2017

In spite of this lack of volatility, for some reason, IV of the short-term options is extremely high, 44 for the series that expires in 10 days.  The company is trying to purchase Humana, and the justice department may have some objections, and there seems to be concerns how insurance companies will fare under the Trump administration, two factors which may help explain the high IV. Neither of the possible adverse outcomes are likely to occur in the next 10 days, at least in my opinion.

AET closed today (Monday) at $122.67.  I think it is highly unlikely that it will fall below $118 in 10 days when the 20Jan17 options expire.  Here is a trade I made today:

Buy to Open 10 AET 20Jan17 113 puts (AET170117P113)

Sell to Open 10 AET 20Jan17 118 puts (AET170117P118) for a credit of $.98  (selling a vertical)

I received $980 less $25 commissions, or $955.  The maintenance requirement, and my maximum theoretical loss in $5000 less the $955 I received, or $4045.  If AET closes at any price higher than $118 in 10 days, both these puts will expire worthless and I will get to keep my $955.  That works out to be a 23% return on my investment, not so bad considering that it is just for 10 days.

In the event that AET is trading below my downside break-even point ($117.06), I will be facing a loss.  If that is the situation, I will roll out this same strike-price spread to a further-out option series, and I should be able to do it at a credit.  That is how I would propose to postpone a possible loss and give the stock some time to return to over $118 where the puts will both expire worthless and give me a greater return than 23% (depending on the amount of the credit I receive).  Of course, I will have to wait longer than 10 days for that profit to come, but I can be a little patient.

Update on Google Options Purchase

Saturday, October 26th, 2013

Two weeks ago I told you about an options investment I made in Google.  This investment was made just before Google was scheduled to announce their earnings for the latest quarter.  For that reason, the October options had skyrocketed in value as they usually do just prior to an announcement, especially the options that will expire shortly after the announcement is made.Google announced earnings after the close on Thursday, October 17th, and the company exceeded expectations by a large margin.  The stock rose over $120 on Friday.

I had made my investment in hopes that it would at least stay flat.  If it did, I would stand to gain about 8% on my investment in only two weeks.  Let’s see how these options did when the stock made such a huge upward swing.

Terry
 
Update on Google Options Purchase:  My original goal was to use call options as a proxy for owning 100 shares of stock.  I discovered that I could buy the equivalent of 100 shares and shell out only $15,500 rather than the $87,000 it would take to buy 100 shares.

As I reported two weeks ago, I bought 2 GOOG 800 calls that expire on the third Friday of January 2014, paying $8600 for each call, or $17,200 in total.

The reason that I bought such deep in-the-money calls is that most of the value was in the intrinsic value of the option rather than the time premium.  Deep in-the-money options don’t carry such a high Implied Volatility as at-the-money options, especially those which expire shortly after an earnings announcement.  That means the calls that I bought were “cheaper” than the October 2013 calls I intended to sell (using my January 2014 800 calls as security).

Since I owned 2 call options at a low strike price I was entitled to use them as collateral to sell someone else the opportunity to buy shares of GOOG at a higher price.  I sold one Oct-13 890 call, collecting $13.50 ($1350) and one Oct-13 935 for $3.50 ($350). 

These option positions gave me the equivalent of 100 shares of GOOG at a cost of $17,200 less the $1700 I collected from selling the two calls, or $15,500.

This was the risk profile graph for my positions that I showed two weeks ago:

Google Risk Profile Graph

Google Risk Profile Graph

Unfortunately, the graph did not extend up to the $1000+ level that the stock moved to, so I will share how I closed out the positions.  When the stock was trading just about $1000 on Friday, I sold one diagonal spread (buying to close the October 2013 890 call and selling to close the January 800 call) and collected $92 ($9200).  That spread had cost me $7250 to buy ($8600 – $1350) so my gain was $1950.  (All these numbers have been rounded to the nearest $50.)

The second diagonal spread (buying to close the October 2013 935 call and selling to close the January 800 call) was sold for $137 ($13,700).  This spread had cost me $8250 ($8600 – $350) so my gain was $5450, giving me a total gain of $7400 on an investment of $15,500, or 47%.

The stock had gone up by 13% and my option portfolio had gained 47%.  How can anyone not love options?

My total commissions on these trades amounted to $10 at the commission rate that thinkorswim offers to Terry’s Tips subscribers.

This is just one example of how I use options to buy the equivalent number of shares of a company I like, and how I can collect a “dividend” each month even if the stock doesn’t actually pay a dividend.  In this case, the stock skyrocketed, and my returns were considerably greater.

Update on Herbalife Spread Positions

Thursday, January 10th, 2013

On Monday I submitted an article to Seeking Alpha -, Why Herbalife Should Move Higher From Here

I recommended buying calendar spreads at one strike below the current price of Herbalife (HLF) and two strikes above the current price so that you didn’t much care which way the stock moved as long as it didn’t go absolutely crazy on the downside.

In a Terry’s Tips portfolio, we bought Feb-13 – Jan2-13 calendar spreads at the 35, 37.5, 40 and 42.5 strikes when the stock was trading at $28.57.  On Tuesday and Wednesday, the stock moved up by about $2.50 and we added another calendar at the 45 strike.

The company has made a public announcement today refuting the claims of Bill Ackman, and the stock has been gyrating in both directions, although not by huge margins.  As I write on my lunch break on Thursday, the stock is trading at $40, down about a dollar for the day.

Our little portfolio has gained 20% after commissions since Monday, and the risk profile graph shows that we should pick up even more tomorrow as long as the stock doesn’t fll by more than another $2 by the close tomorrow:

I am a little tempted to close out the positions and take a 20% gain for the week, but the break-even range seems large enough that I will wait another day and  hope for another 10% or so.

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