Update on the Green Mountain Coffee Roasters (GMCR) Trade

On Monday, I wrote to my free newsletter subscribers and recommended the following trade in advance of the company’s earnings announcement after the close on Wednesday:

Buy To Open 10 GMCR Jun-13 52.5 calls (GMCR130622C52.5)

Sell To Open 10 GMCR May2-13 57 calls (GMCR130510C57) for a debit of $3.70 (buying a diagonal) 

This spread would make a gain for the week if the stock managed to fall by less than 10%, stay flat, or go up by any amount.  The maximum gain would come if the stock fell by about $2 (to $57) after the announcement.

I also wrote a Seeking Alpha article explaining why I believed that the company would exceed expectations but the stock would fall slightly after the announcement for a couple or reasons (primarily because expectations were so high) – How To Play The Green Mountain Coffee Roaster…

My analysis on the earnings announcement was right on the money, but the company also disclosed that they had signed a 5-year deal with Starbucks (SBUX) that caused the stock to shoot higher by about 25%.  In my defense, there was no way I could have known about this wonderful news for GMCR stockholders.

I was able to sell the spread for only its intrinsic value ($4.50) because the stock had moved so much higher.  That resulted in a gain of 20% after commissions for the trade.

In most investments, a 20% gain in three days would be considered a fantastic return.  Actually, I was a little disappointed. I could have made double that amount if the
Starbucks news had come along at some other time than today.

Over a million dollars was invested in the GMCR Jun-13 52.5 calls on Monday after I made my recommendations, double or triple near-by option volume.  Clearly, lots of people heeded my advice.  I hope they are satisfied with a 20% return for the week.  I guess I am, reluctantly.

The spreads I suggested buying a week ago in advance of the Questor (QCOR) earnings announcement resulted in a gain of 13.6% for the week.  We were correct in the direction the stock would take (higher) but we underestimated how much it would rise.  We lost money on the calendar spread but made it back and more in the vertical spread we placed at the same time.

While we were disappointed with our return, 13.6% per week on an annualized basis works out to a pretty big number.

This week I am sharing what I believe is one of the best option investment possibilities I have seen in a very long time.

If you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free!

Terry

How to Play the Green Mountain Coffee Roasters Earnings Announcement

For the three following reasons, I believe that Green Mountain Coffee Roasters (GMCR) will exceed expectations when they announce earnings after the close on May 8, 2013:

1. The company has matured under its new CEO (from Coca-Cola).
2. Raw coffee prices have fallen steadily and single-cup prices have not been reduced.
3. Hedge funds have started buying stock heavily.

Since there is often a big difference between how good earnings might be and what happens to the stock price, there seems to be conflicting indications on what the price of GMCR might be at the end of the week.  Most importantly, expectations seem to be sky-high.  Whisper numbers are 8.3% higher than analysts expect, and the stock has steadily climbed by 30% over the last quarter.  Many times, unless there are blow-out earnings such as we saw in Netflix a couple of weeks ago, the stock trades lower.

On the other hand, short interest (39% of the float) continues to be exceptionally high (bringing the possibility of a short squeeze).  If earnings do manage to exceed expectations as I think they will, there might be a lot of short covering that will boost up the stock price.

Bottom line, I think the most likely scenario is that earnings will be good and the stock dips a bit.  With this in mind, here is the spread I placed this morning in three Terry’s Trades portfolios as well as my personal account:

Buy To Open GMCR Jun-13 52.5 calls (GMCR130622C52.5)

Sell To Open GMCR May2-13 57 calls (GMCR130510C57) for a debit of $3.70 (buying a diagonal) 

This spread should make a gain if the stock falls by less than 10% after the earnings announcement, stays flat, or goes up by any amount.  If the stock fluctuates only slightly, a gain as large as 50% might result.

Later today, Seeking Alpha will probably publish an article giving fuller details of my reasoning outlined above.  The title will be How to Play the Green Mountain Coffee Roasters Earnings Announcement.  If they don’t publish it (presumably because it is too much a pure options play), I will send you the full article later today.

I feel very good about this spread.

Last week I suggested that you “purchase May – Apr4 calendar spreads on AAPL at the 410 and 420 strikes, paying $3.85 and $3.75 for them in hopes that AAPL moves higher than its $390 price that it closed at Friday.”  We did just that in a Terry’s Tips portfolio.

The stock did manage to move up and we sold these spreads early on Friday for $6.86 and $4.66.  We sold early because we had such a good gain and because Fridays are usually weak for AAPL (people tend to sell Weekly call premium on that day and depress the stock price).  A lower price would have resulted in a lower gain because all of our strikes were higher than the stock price.  The stock managed to move up by $8 after we closed out the spreads, and we would have done considerably better if we had waited (but taking a sure profit is our preference, and we shouldn’t look back – it only hurts).

Our gain on the spreads worked out to be 50% after commissions.  We will take that any week.

If you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free!

Terry

A Possible Earnings Play for This Week

Questor Pharmaceuticals (QCOR) is an interesting company which suffered a huge setback in September 2012 when an insurance company which handled 5% of the company’s claims decided that it would no longer cover the expensive drug that represents essentially all of QCOR’s sales.

Since that time there have been no other insurance companies to deny coverage, and many institutional investors and hedge funds have purchased stock recently, presumably after surveying other insurance companies to learn if they had any intention to do so.  In contrast to that bullish event, over the past two weeks, short interest has increased by 3.1 million shares to 27 million while the outstanding float is only 54 million.  In other words, shares sold short represent 50% of the float.  Clearly, some people are hoping that other insurance companies will deny coverage and the stock will tank once again.

For many reasons, QCOR seems to be a screaming buy.  It has been growing at a good rate, carries a forward P/E of only 5, has no debt, and has multiple consecutive quarters of top line and bottom line analyst beats.  In my opinion, if earnings beat estimates once again, a short squeeze might send the stock considerably higher.

The stock has fallen about 22% over the past month, an indication that expectations are not exceptionally high (although it has recovered about 8% in the past week).  I believe there is a strong chance that it will trade higher after the announcement, and plan to make the following trades just before the close on Tuesday (earnings will be announced after the close on that day):

Buy To Open 10 QCOR May1-13 27 calls (QCOR130503C27)

Sell To Open 10 QCOR May1-13 32 calls (QCOR130503C32) for a debit of $2.30  (buying a vertical)

Buy to Open 10 QCOR Jun-13 30 calls (QCOR130622C30)

Sell to Open 10 QCOR May1-13 30 calls (QCOR130503C30) for a debit of $1.50  (buying a calendar)

This is what the risk profile graph looks like if we assume that implied volatility (IV) of the June options falls by 15 (from 65 to 50) after earnings are announced:

 QCOR Risk Profile Graph

These positions will cost about $4500 to place.  If the stock stays flat, a small gain should result.  If it moves higher by any reasonable amount, a larger gain should come our way.  However, if the stock falls more than just a small amount, a loss would result.

I feel good enough about this company to take this bullish position for Tuesday’s earnings announcement.

The SanDisk spread I recommended to buy last week generated a 68% gain after commissions in a Terry’s Tips portfolio.  This week I have two other suggestions, one of which you must buy in the next hour or so after this is being sent out.

Also, if you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free!

Terry

Expectations Trump Results

This week we got lots more support for our premise that expectations are more important than the actual results when a company announces earnings.  Not only did we score big-time with a bearish bet on SanDisk but we saw that expectations were dreadfully low for Google and we bought calendar spreads at strike prices much higher than the pre-earnings stock price and more than doubled our investment on both of them.

Last week I wrote a Seeking Alpha article which examined several companies that were announcing earnings this week – 3 Earnings-Related Plays For Next Week.  In this article I identified two companies with unusually low expectations  – AAPL and Caterpillar (CAT) and recommended placing bullish options spreads on them. CAT announced before the open today and they fell short on both earnings and revenue, and reduced future guidance as well (all bad news), but the stock is trading $2.40 higher as I write this.

We have purchased May – Apr4 calendar spreads on AAPL at the 410 and 420 strikes, paying $3.85 and $3.75 for them in hopes that AAPL moves higher than its $390 price that it closed at Friday.

We also identified a company with excessively high expectations – NetFlix (NFLX).  The stock is up over $12 today in anticipation of the announcement after the close today.  An analyst upgraded them today which contributed to the rise.  With NFLX trading at $175 we are buying May 180 puts and selling Apr-4 175 puts as a diagonal spread.  It should make money if NFLX stays flat or falls by any amount.  This is the trade that you only have a couple of hours to get if you are interested.

I have written another article which I believe is very interesting but which hardly anyone has read so far – What Earnings Season Tells Us, So Far.  It points out that 13 of the 15 large companies with Weekly options which have reported so far have exceeded analyst expectations but 9 of them fell in price after the announcement.

Update on SanDisk (SNDK) Earnings-Related Option Play

Last week in a Seeking Alpha article – How To Play The First Week Of The April Earnings Season  I showed how SNDK had excessive expectations going into its earnings announcement (whisper numbers exceeded analyst expectations by 18.7%, the stock had soared over the last week and month, and implied volatility of Weekly options was 50% higher than IV of the May options.

With the stock trading at $57.50, I recommended buying May-13 57.5 puts and selling Apr-13 55 puts.  The natural price for this spread at Friday’s close was $1.63.  Shortly after the open on Monday in an actual portfolio conducted at Terry’s Tips, we were able to buy this spread for $1.61 in our Earnings Expectation portfolio.  We bought 15 spreads, shelling out $2452.50 including commissions.

The announcement exceeded earnings expectations and revenue grew 14%, but the excessive expectations drove the stock down to about $55 at the open on Thursday.  We closed out our spread shortly after the open, collecting $2.77 per spread, or $4117.50 after commissions.  Our gain for the trade amounted to $1665, or 68%.

It was a good week.

This week I will offer a simple spread idea that could make 50% in a couple of days next week.  It will cost about $170 per spread to put on. 

Also, if you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free! 

How to Use Expectations to Prosper With Earnings Announcements 

The earnings season started just last week.  In my last Idea of the Week I recommended buying a straddle on JPMorgan (JPM), the first big company to announce this time around.  We made that trade in an actual portfolio for Terry’s Tips subscribers and closed it out for a 15%+ gain after commissions. 

I also suggested an options strategy for JPM in a Seeking Alpha article – How To Play The JPMorgan Earnings Announcement.  In another Terry’s Tips portfolio  we placed calendar spreads as outlined in this article and closed them out for a gain of 15% after commissions even though the stock fell a little after the announcement while we were betting that it would go higher. 

A wonderful thing about options is that you can be wrong and still make profits as we did last week in our JPM trades.  Terry’s Tips subscribers who followed both portfolios made over 30% last week, more than most people make in an entire year of stock market investing. 

This week I wrote another Seeking Alpha article which checks out seven big companies which announce this week – How To Play The First Week Of The April Earnings Season.  

The major message of this article is that the price of the stock after the announcement is more dependent on pre-announcement market expectations than the actual numbers that the company releases.  If expectations are too high, the stock will fall no matter how much the company beats the analysts’ projections. 

Of the seven companies reviewed, SanDisk (SNDK) seemed to have the highest level of expectations.  Whisper numbers were 18.6% higher than analyst projections, the stock had shot up over 10% to a new high over the last week, and had moved 5% higher in the last week alone.  We believe that it is highly likely that some investors will “sell on the news” no matter how good it is, and the stock will either stay flat or fall after the announcement. 

With the stock trading about $57.70, I am buying May 57.5 puts and selling April 55 puts. Implied volatility (IV) of the May options is 37 while the April options carry an IV of 70, nearly double the May number (this means you are buying “cheap” and selling “expensive” options).  Each diagonal spread would cost $163 to place at the natural option prices at the close on Friday. 

Here is the risk profile graph for these spreads if you bought 20 of them, investing about $3400 after commissions (of course, you could buy fewer, or more, if you wished): 

SNDK Risk Profile Graph

This graph assumes that after the announcement, implied volatility (IV) of the May options will fall from its current 37 to 30 which is more likely in a non-announcement time period.  The graph shows that when you close the positions on Friday, April 19^th, a double-digit gain could be made if the stock holds steady, and could nearly double your investment if it fell about $2 ½ after the announcement.  A profit would result no matter how far the stock might fall in value. 

We think the stock is likely to fall after the announcement because expectations are so unusually high.  If it moves higher, however, a loss could very well result.  Even in the world of options, there is no free lunch.  You need to take a risk.  We like our chances here.

Most of the time I prefer to sell options with just a few days or weeks of remaining life and collect the premium that is decaying at a higher rate than ever before.  However, this policy is not always the most profitable alternative out there.  Today I would like to discuss one of those situations where buying options rather than selling them might be the better bet. 

If you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free! 

An Interesting Straddle Purchase Opportunity in J.P. Morgan (JPM)

 Implied Volatility (IV) of an option price is supposed to measure the market’s expectation of how much the underlying security will fluctuate in one year.  If an options series has an IV of 20, the market expects the stock will move either up or down by 20% over the course of a year. 

Sometimes there is a huge difference between IV of the options and the actual price behavior of the stock.  For example, check out J P Morgan (JPM).  The April options have an IV of 24 with three weeks of remaining life, and this IV is unusually high because an earnings announcement is due on April 12 (before the open), and volatility is usually higher than normal after announcements. 

So how much did JPM fluctuate over the past year?  On June 4, 2013 it hit a low of $30.83 and on March 15, 2013 it hit a high of $51.00. This is a 64% change, more than triple the IV of the options.  In other words, options are relatively inexpensive compared to the actual volatility of the stock. 

When you see a situation like this, the best options play might be to buy a straddle (both a put and a call) at an at-the-money strike and hope that the stock fluctuates as it has in the past. 

Right now, with JPM trading at $47.50, you could either buy an April 47 or 48 straddle for about $2.00 (if you think JPM is headed higher, you would select the 47 strike, and if you think JPM is more likely to fall, you would choose the 48 strike).  If the stock fluctuates more than $3.00 in the next three weeks, you could sell your straddle for a 50% gain.  (The nice thing about straddles is that you don’t care whether the stock goes up or down, just as long as it moves.) 

So how likely is JPM to fluctuate by at least $3.00 in a month?  Here are the biggest and smallest moves it has made over the past 25 months: 

 I have highlighted the months in which the stock fluctuated at least $3.00 in either direction (enough for you to make a 50% gain on a $2.00 straddle purchase).  For those months, a 50% gain would be possible in 17 out of 25 months (68% of the time).

 Admittedly, in this example with April options, there are only three weeks rather than four for the stock to fluctuate by this much, but since this time period includes an earnings announcement, greater volatility can be expected in this three-week period than a normal (no earnings announcement) month. 

If you were to buy an April straddle on JPM for $2.00 and place a good-til-cancelled order to sell it if it hit $3.00, you would gain 50% on your investment (less commissions).  If it did not execute in the next two weeks, I would recommend selling it when there was one week remaining for the April options.  If the stock is trading exactly at the strike price of your straddle, you would probably get back half of your $2.00 cost, losing 50%.  If the stock is at any other price than exactly at your strike price, you should be able to sell the straddle for more than $1.00.  If the stock is as little as $1.00 higher or lower than your strike price, you should be able to get back $1.50 of your original $2.00 cost by exiting (selling) the position with a week of life remaining in the option.  If the stock is $2.00 away from the strike price, you should be able to sell the straddle at a profit. 

The stock does not have to fluctuate by $3.00 for you to sell an at-the-money straddle for $3.00 since there will always be some time value to the options (over and above the intrinsic value) right up until the options expire. 

I like the odds of this straddle purchase and plan to do it both in my personal account and in one of my portfolios that I conduct at Terry’s Tips

Last week I told you about a pre-earnings announcement on Nike.  With the stock trading around $65, we bought calendar spreads at the 62.5, 65, and 67.5 strikes for an average of $.33 each, guessing that if the stock ended up near any one of these strikes, that spread would be worth over a dollar and cover all three spreads. The stock shot up more than 11% after the announcement, and was closest to the 70 strike.  The calendar spread at that  strike was worth $1.20, so we were right on that score.  But we didn’t have any spreads at that strike, and we lost money for the day.  In future calls in companies like Nike which have a history of big moves after announcements, we will add extra out-of-the-money calls and/or puts to provide insurance against huge moves of this size. 

If you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free! 

Buying a Straddle on Oracle 

On Friday, with Oracle (ORCL) trading at $32, I bought an April straddle (both a put and a call) at the 32 strike.  The straddle cost me $1.40.  The stock will have to move in either direction at least $1.40 for the intrinsic value of my straddle to be at break-even (although it will not have to move that much for the straddle to be able to be sold for a gain as there will always be some extra premium value in the options I own).

 Let’s look at how much Oracle has fluctuated each month for the past two years:  

Oracle Monthly Price Changes Last Two Years

Oracle Chart March 25 2013

Only two times in the last two years has Oracle failed to move at least $1.40 in one direction or another in a single month.  That means that an at-the-money straddle purchased for $1.40 at the beginning of the month could have been sold for a profit at some point during that month 22 out of 24 times. 

Many times, there would have been an opportunity to more than double your money, and while the maximum loss is theoreticlly $1.40 per spread, last week, with a week of remaining life, the 32 at-the-money straddle could have been sold for $.72 which means that if you closed out the spread with a week remaining, the worst you could do would be to recover half your initial investment.  (If the stock were at any price higher or lower than $32, the straddle would be worth more than $.72 with a week remaining). 

The big challenge with these kinds of spreads is deciding when to sell.  One way is to place a limit order when the spread reaches a certain profit level, say 50%, and take that gain whenever it comes.  In our example, that would mean placing an order to sell the straddle at $2.10.  The above table shows that in more than half the months (13 out of 24), you could have sold the straddle for at least a 50% gain.  I like those odds. 

The stock does not have to fluctuate the full $2.10 in order for the straddle to be sold at that price.  As long as there is time remaining in the options you hold, they will be worth more than the intrinsic value.  The $2.10 price might be hit if the stock only fluctuates $1.80 or so if it does it early in month. 

Another way of selling the spread is to place limit orders at slightly more than what you paid for the straddle if either the put or call reaches that price.  You might place a limit order to sell the puts at $1.43 and another order to sell the calls if they reach $1.43.  In either case, you get all your money back (plus the commission) and you have either puts or calls remaining that might be worth a great deal if the stock reverses itself and moves in the opposite direction.  The stock might have to move only about $1.20 in either direction for one of these trades to execute. 

We typically place orders to sell half of our original spreads if either the puts or calls can be sold for the original cost of the straddle.  That way we get half our money back (almost assuming that we will not lose money for the month) and if the stock continues in the direction it has started, a huge gain might be made on those remaining options, and if the stock reverses, you have twice as many of the other options that might grow in value. 

Most of our investments at Terry’s Tips involves selling premium and waiting over time for decay to set in, all the time hoping that the stock does not fluctuate too much (as that hurts calendar spreads).  It is fun to have at least one investment play that does best if the market does fluctuate, and the more the better.  Buying a straddle on Oracle gives us that opportunity, and the history of the stock’s fluctuations shows that it is a pretty good bet.

While the earnings season is winding down, there are several companies announcing this week, and we are trading three of them.  I would like to share one of these with you, the one involving Nike. If you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free!

How to Play the Nike (NKE) Earnings Announcement

Calendar spreads in NKE seemed so attractive that we placed 20 Apr-Mar4 spreads last week at three different strikes for an average cost of only $.33 – if the stock ends up anywhere between $52.50 and $57 (currently about $54.50), the long side of one of those spreads with four weeks of remaining life should be worth at least $1.00, more than covering the cost of all three.  

I checked prices this morning and the three spreads could be purchased for only a little more – an average of $.35. 

NKE announces earnings on Thursday, March 21^st after the close.  Expectations seem to be high – whisper numbers are $.76 vs. analysts’ projection of $.68 and the stock has gained 20% over the past three months  – high expectations typically cause disappointment with some part of the announcement and a lower stock price afterwards. 

We will want to place trades that will allow for the stock to drop in price by a greater percentage than it could go up and still make a gain on the spreads.  Here are the trades that we placed:

NKE Graph for newsletter march 2013

NKE Graph 2 for newsletter march 2013

These spreads cost a little less than $3500 to place.  The diagonal put spread is the most expensive, but will about double in value if the stock moves down to $52.5 or lower. 

Here is the risk profile graph which shows the likely gains or losses at the close of trading on Friday:

Implied volatility (IV) of the Mar4-13 options (43) is nearly double that of the Apr-13 options (23) which gives us a large IV advantage with these calendar spreads.  In the above graph, we assumed that IV of the April options would fall to 20 after the announcement. 

The graph shows that if the stock falls less than 8% on Friday or goes up by less than 5%, we should make a gain with our positions.  The highest gain (about $2000 on an investment of about $3500) would come if the stock were to fall about $2 after the announcement. 

We like our chances here.   

_________________________

Any questions?   I would love to hear from you by email (terry@terrystips.com), 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. 

You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself?

Even better, you can become a Terry’s Tips Insider, and receive all our educational reports and materials absolutely free by opening a new account at the best options broker around – thinkorswim. Use this link to sign up – open thinkorswim account – and once you have funded your account with at least $3500, email Seth@TerrysTips.com and let him know that you have done it, and this is what he will do – sign you for our Premium Service package ($119.95 value plus an extra 4 months of our Premium Service, valued at another $190.80).  You get $300.65 worth of services without paying us one penny.

A lot of our discussion lately has focused on pre-earnings-announcement strategies (we call them PEA Plays).  This has been brought about by lower option prices (VIX) than we have seen since 2007, a full six years ago.  With option prices this low it has been difficult to depend on collecting premium as our primary source of income with our basic option strategies. 

But the earnings season has now quieted down and will not start up again for several weeks, so we will return to discussing more conventional option issues. 

Terry 

Using Puts vs. Calls for Calendar Spreads 

 It is important to understand that the risk profile of a calendar spread is identical regardless of whether puts or calls are used.  The strike price (rather than the choice of puts or calls) determines whether a spread is bearish or bullish.  A calendar spread at a strike price below the stock price is a bearish because the maximum gain is made if the stock falls exactly to the strike price, and a calendar spread at a strike price above the stock price is bullish. 

When people are generally optimistic about the market, call calendar spreads tend to cost more than put calendar spreads.  For most of 2012 and into 2013, in spite of a consistently rising market, option buyers have been particularly pessimistic.  They have traded many more puts than calls, and put calendar prices have been more expensive. 

Right now, at-the-money put calendar spreads cost more than at-the-money call calendar spreads.  As long as the underlying pessimism continues, they extra cost of the put spreads might be worth the money because when the about-to-expire short options are bought back and rolled over to the next short-term time period, a larger premium can be collected on that sale.  This assumes, of course, that the current pessimism will continue into the future.

If you have a portfolio of exclusively calendar spreads (you don’t anticipate moving to diagonal spreads), it is best to use puts at strikes below the stock price and calls for spreads at strikes which are higher than the stock price.  If you do the reverse, you will own a bunch of well in-the-money short options, and rolling them over to the next week or month is expensive (in-the-money bid-asked spreads are greater than out-of-the-money bid asked spreads so you can collect more cash when rolling over out-of-the-money short options). 

The choice of using puts or calls for a calendar spread is most relevant when considering at-the-money spreads.  When buying at-the-money calendar spreads, the least expensive choice (puts or calls) should usually be made. An exception to this rule comes when one of the quarterly SPY dividends is about to come due.  On the day the dividend is payable (always on expiration Friday), the stock is expected to fall by the amount of the dividend (usually about $.60).  Since the market anticipates this drop in the stock (and knowing the specific day that the stock will fall), put prices are generally bid higher in the weeks before that dividend date. 

The bottom line is that put calendar spreads are preferable to call calendar spreads for at-the-money strikes (or even at strikes slightly higher than the stock price) coming into a SPY dividend date.   Even though the put spreads cost more, the Weekly options that can be sold for enough extra to cover the higher cost.  You do not want to own SPY call calendar spreads which might become in the money on the third Friday of March, June, September, or December because you will have to buy them back on Thursday to avoid paying the dividend, and you may not want to make that purchase to keep your entire portfolio balanced.