Today I would like to tell you about an actual trade I made today in my personal account as well as two Terry’s Tips portfolios. The underlying is Green Mountain Coffee Roasters (GMCR) which is located in my home state of Vermont and is one of my favorite companies.This trade will make a nice gain if the stock stays flat or moves higher by any amount between now and 17 days from now, just after earnings are announced.
If the company disappoints in any way and the stock falls, I will have plenty of time to recover by selling new calls against my long positions over the next five months.
I believe this spread has an excellent chance of making a nice gain and there seems to be almost no chance that I will lose money on it even though it might take a little time to at least break even.
An Earnings Play on Green Mountain Coffee Roasters
GMCR announces earnings after the close on February 5, 2013. The weekly options that expire a couple of days later, on February 7 are trading at extremely high valuations (implied volatility (IV) is 65). I would like to sell some of that premium.
I am bullish on this company. Two insider directors recently bought over a million dollars each of the stock (and they aren’t billionaires). The company is buying back shares every quarter, so they must believe it is a good purchase.
One company wrote a Seeking Alpha article in which they picked GMCR as the absolute best company out of their database of over 7000 companies. Only a handful of other companies have met this criterion in the past, and on average, their stock has outperformed the S&P 500 by a factor of three. Check it out – Green Mountain Coffee Roasters: The Fundamental King.
I bought a diagonal call spread, buying GMCR Jun-14 70 calls and selling Feb1-14 80 calls. The spread cost me $9.80 at a time when the stock was trading at just below $80. If the stock moves higher, no matter how high it goes, this spread will be worth at least $10 plus the value of the time premium for the 70 call with about 5 months of remaining value, no matter how much IV might fall for the June options. The higher the stock might soar, the less I would make, but I expect I should make at least 20% on my money (if the stock moves a lot higher) in 17 days.
This is what the risk profile graph looked like at the end of the day today. (In this portfolio, one of the 10 we conduct for Terry’s Tips subscribers to follow), I bought 6 spreads which just under $6000. Commissions were $15. It shows the expected loss or gain on the investment on February 7th when the short calls expire:
gmcr risk profile graph jan 2014
If it stays flat I should make about 40% (the graph shows more, but IV for the June calls will most likely fall). If it falls more than $5, I will be looking at a paper loss, but will still own 70 calls with 5 months of remaining life. I should be able to sell weekly calls against these June 70 calls and recoup any paper losses that might come my way if the company disappoints on announcement day.
I believe this is a very safe bet that is highly unlikely to result in a loss, although I may have some money tied up for a while if the stock does tank after announcing. But as usual, I hope that no one will take the risk with money that they can’t afford to lose.