Options Strategy for the Green Mountain Coffee Roasters Earnings

After the market close tomorrow, Green Mountain Coffee Roasters (GMCR) will announce quarterly and year-end earnings.  I am quite bullish on the stock, and have written a Seeking Alpha article explaining why – Why Green Mountain Coffee Roasters Will Soar This Week 

(I apologize for its being so long, but as Abraham Lincoln once said in a letter he wrote to a friend, I didn’t have enough time to make it shorter.)

Options Strategy for the Green Mountain Coffee Roasters Earnings

If you I have a strong feeling for a particular stock prior to their making an earnings announcement, there are a couple of strategies I like to employ.  I would like to tell you about one of them today.  It involves a little hedge just in case I am wrong (with this hedge, I won’t lose all my money). 

An aggressive strategy if you were very bullish on a stock would be to sell an at-the-money put in the shortest-term option series available (for GMCR, (that would be the Feb2-13 options expiring on Friday February 8, two days after the Wednesday after-close announcement).  Option prices in this series tend to escalate to about double or triple their usual implied volatility, making them very “expensive”.  Since you don’t want to sell any option all by itself (they call that naked selling because that’s how you feel whenever you do it, totally exposed), you must buy some other  put to cover yourself (and avoid a horrendous margin requirement from your broker).  If you bought lower-strike Feb2-13 puts, you would collect a credit on your spread sale (called a vertical put spread), and there would be a maintenance requirement of $100 for each dollar of difference  between the strike prices. 

For example, with GMCR selling about $48, you could buy a Feb2-13 43 put and sell a Feb2-13 48 put and collect about $2.  There would be a maintenance requirement of $500 less the $200 you collected from the vertical spread sale.  Your maximum loss is $300 and this would come about if the stock fell to below $43 from the $48 where it was before the announcement. 

With this spread, you are hoping that the stock closes on Friday at any price above $48.  If it does, both your long and short puts will expire worthless and you save paying commissions on closing out the positions.  You just end up with $200 (per spread, less commissions) in your account and the maintenance requirement goes away.  You would have made about 65% after commissions on your $300 at risk. 

What I do (the hedge) is a little different.  Instead of buying the lower-strike put in the same series, I go out to a longer period series.  I might buy a Feb-13 43 put (which expires February 15, a week later) instead of the Feb2-13 43 put.  It would only cost me about $.30 more (i.e., I would collect about $1.75 instead of $2.00 at the beginning), but if I wrong about GMCR and the stock falls instead of moving higher, this put might have a decent value when the Feb2-13 45 put expires in the money.  If the stock is below $48 at expiration, I will buy it back on Friday and sell my Feb-13 43 put at the same time.   

If the stock falls over $3, I will probably lose money on the original spread, but I will gain some of the loss back from selling the Feb-13 43 put.  It is not a perfect hedge, but it reduces the maximum loss from $300. 

I have placed this exact spread in my personal account – it is called buying a diagonal put spread.  I received $1.75 and hope to collect that much per spread on Friday (plus whatever I can collect from selling the Feb-13 43 put that that has a week of remaining life.