Nasdaq Dips Under 2800 As Slide Continues
PowerRating) is up 4 points to 59 1/4 as a possible Quaker Oats
sours. Home Depot
PowerRating), down 1 to 37, continues its slide as Lehman
lowers EPS. Yahoo
PowerRating) starts the funeral march, trading as
low as 38 today.
Option volatilities aren’t heading south as they usually do in the November and
December holiday season. As long as market exerts pressure on the downside
and earnings problems continue, volatilities will stay up (humbug!).
Let’s take a look at Sun MicroSystems
PowerRating), which is down 20% in
the last two weeks to $80. If you believe that the stock will bounce up
10% over the next two months, what would you do?mso-ansi-language:EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA”>
is what we would consider: Since option volatilities are in the upper end of
their yearly range — around the 80 level — we would look at a Bull Call Spread,
rather than simply buying calls. The Bull Call Spread will negate the high
volatility that will hurt Call buyers.
A Bull Call Spread that we are considering is buying the Jan 80 Call (10 3/4)
and selling Jan 90 Call (6 1/4) for a 4 1/2 debit.
Risk Management: If the stock goes up to 90 or higher, the spread will to
$10. The trade would make $5 1/2 (less commissions). This is over a
100% return in two months! Breakeven is 84 1/2. If we end up being
wrong about the upside move, we would lose our entire debit if the stock closes
at 80 or lower.
As professional traders, if we are wrong on the near-term direction of the stock
price, we might roll down the spread and be long the 75-85 or even the 70-80
spread. Also, if we’re just plain wrong on our assumption that the stock
is going to go up, we might just cut our losses (often good risk management) and
exit the spread at 2 1/4 for a 50% loss on our initial outlay.