LXK Falls Out Of Bed And May Keep On Sliding…

  • July 23, 2001
  • Jon Najarian

The
day after expiration is normally one of the slowest days of the month, and thus
far, today’s session is following that script. Stocks are near session lows as
initial euphoria over the Cisco
(
CSCO |
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PowerRating)
upgrade wore off and we got back to business as usual.

3M
(
MMM |
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PowerRating) didn’t provide any boost with
in-line earnings, due to growing weakness in its overseas markets and the strong
U.S. dollar. Clearly, the bulls were hoping for better from the Minnesota-based
industrial giant and the selloff reflects that slackening of optimism. Lexmark
(
LXK |
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PowerRating) didn’t do the bulls any favors either when the second-largest
printer maker eked above the earnings bar but announced third- and fourth-quarter earnings would fall considerably under
Street estimates.There are a few ways traders are going
to play for a
test in LXK back to the $40 level. They can always short the stock and violate
one of my basic rules of investing, or they may take a controlled amount of
risk and buy a put spread. With LXK trading for $51, they are buying the September
50 puts for $4.60 and selling a like amount of September 40 puts for $1.30.
Their total risk in the position is defined on entry at that $3.30. A 10 x 10 bear put
spread will set them back $3,300, but a close at $40 or lower in LXK means that
$3.30 investment would be worth $10, or $10,000 on that 10 x 10 bear put
spread.

As with any spread, you needn’t hold it all the way to expiration. Our models
show that a drift lower to $45 in the next 20 days would make our short calls
worth $1.69, while our long 50 puts would expand to $6.84. That might not seem
like such a huge winner, but remember, you only paid $3.30 for the spread that
would be worth $5.15, a return of over 55%!

Options involve risk and
are not suitable for all investors. Prior to buying or selling an option, a
person must receive a copy of Characteristics
and Risks of Standardized Options. Copies of this document are available
from your broker or the Chicago Board Options Exchange, 400 S. LaSalle Street,
Chicago, IL 60605.