Stock Options Trading Idea of the Week
Interesting Option Opportunity -XLF
This week I would like to tell you about an exciting new portfolio we set up last week to take advantage of unusually attractive option prices in a particular ETF.
Interesting Option Opportunity -XLF
We set up a new portfolio this week to capitalize on a huge Implied Volatility Advantage that exists in the financial ETF (XLF). We call it the Leaping Lizard 2 portfolio. March options carry an IV of 94% while Jan-11 options have only a 64% IV. An at-the-money Jan-11 call can be bought for $288 while a March same-strike call can be sold for $87. It would only take selling such a short-term option 4 times over the 23-month life of the LEAP to recover its entire cost. All future short-term option sales would be clear profit.
About XLF: It is the Financial SPDR, made up of 81 companies that comprise a wide array of diversified financial service firms with business lines ranging from investment management to commercial and investment banking. These companies make up about 10 ½% of the SPY components. It is an extremely actively-traded ETF - with more shares changing hands each day than QQQQ. Here are the 24 largest firms in the ETF:
Components and weightings of XLF.
The Leaping Lizard 2 portfolio was set up with $5000. It is a long-term strategy. We have almost two full years over which to sell short-term premium and recover the average $200 we paid for each 2-year LEAP. At the 8 strike, we will recover 25% of the LEAP cost in the first month, and have 22 more months remaining to sell new premium.
On the day after we set up this portfolio, somehow word got out that the government was giving consideration to nationalizing banks. The market concluded that if this occurred, the currently low stock prices for banks might go all the way to zero. Many banks which are part of this financial index suffered dramatically lower stock prices. Citigroup fell by 25%, for example. There was some reprieve later in the day on Friday when the government made a statement that they still believed in private banks, but it was not a full recovery.
This is what the risk profile graph looked like after XLF fell 8%:
The risk profile graph shows that if the stock were to rise only to $9 (a likely scenario since it was selling above that price only a week ago), the portfolio might gain as much as 50% in a single month.
We think this portfolio offers extremely good odds for long-term success for our subscribers. You can see every trade we made to set this portfolio up last week so that you could duplicate it yourself if you wanted. It could easily be set up with $2500 rather than the $5000 we used, by the way.
Terry
Andy's Market Report
The market struggled mightily again this during the holiday-shortened week. Most of the losses came in response of the uncertainty surrounded the banking sector. The idea of nationalizing the banks did not go over well in the stock market and it showed as the Dow moved to new five-year low at 7249, losing 6.2% on the week. The S&P, NASDAQ and Russell lost 6.9%, 6.1% and 8.3%, respectively."It was a market that was built on that hope, and what we're seeing now is an unwinding of that," said Todd Salamone, director of trading and vice president of research at Schaeffer's Investment Research in Cincinnati, of the rally from late November to early January.
The losses began as soon as the market opened Tuesday. Moody's stated the current recession could be more severe in emerging European economies, which would have a direct affect on their Western European parent companies. To make matters worse whispers of a nationalization of some of the largest U.S. banks troubled Wall Street and led to most of the sharp losses.
Citigroup and Bank of America fell 20% on Friday alone. The losses were so devastating that Washington felt obligated to make a statement.
"This administration continues to strongly believe that a privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government," White House Press Secretary Robert Gibbs said when asked about nationalizing the banks.
The statement from Mr. Gibbs helped the market bounce off the lows for the session but know one knows for certain if it will lead to further upside over the short-term.
To make matters worse, the economic news was once again troublesome with no end in sight.
The Empire Manufacturing survey came in at -34.7 well below expectations of -23.8. Core PPI came in hot at 0.4% well above the 0.1% economists' predicted. Housing starts also came in well-below expectations at 466K. The reading is 56.2% from last year.
"Right now, more than a crisis in mortgages or in housing, we have a crisis in confidence. That is biggest problem in trying to analyze the current market," said James Stack, president of market research firm InvesTech Research in Whitefish, Mont. "You cannot analyze psychology."
On a technical basis, the major indexes have moved into a short-term oversold to very oversold reading. This typically means that a short-term bounce is in the making or at least a short-term reprieve. I do expect tp see this tendency play out next week, but as for how long it lasts, well, that is the question everyone would like the answer to as we move further into 2009.
Overbought/Sold Condition Report
Overbought/Oversold as of February 20, 2009
Major Benchmarks- Dow (DIA) - 12.8 (very oversold)
- S&P 500 (SPY) - 15.0 (very oversold)
- Russell 2000 (IWM) - 15.5 (very oversld)
- Nasdaq 100 (QQQQ) - 27.4 (oversold)
- Oil Services (OIH) - 32.5 (neutral)