Options Mojo: Riding the Volatility Wave

Oracle reported earnings today after the market close. The December options expire tomorrow had tremendously high implied volatility (IV) before the close today.

I was bullish on ORCL shares, but wanted to put on a trade that would take advantage of the high implied volatility (and may position myself for a nice rally into January 2011).

The trade I had put on is a Dec/Jan 32.00 Calendar spread. I sold the Dec 32-strike CALL and bought the Jan 32-strike CALL. The trade is most profitable if ORCL trades at 32.00 by 4:00 PM tomorrow with 1 to 2.5 risk/reward.

On Nov 30, I discussed in the article entitled “Volatility Squeeze in Whole Foods Market Inc. (WFMI)” why I had expected the shares of WFMI to go higher. It has done exactly that since then, trading now at 49.50.

Although I do expect WFMI shares to continue the ride, there might be some headwind when it reaches the psychological 50.00 mark. If you think that WFMI will trade right around 50.00 next Friday, Dec 17 (options expiration day), then you can put on a Dec 2010/Jan 2011 49/50 CALL Diagonal Spread (You buy the Jan 2011 49-strike CALL and you sell the Dec 2010 50-strike CALL against it)).

The whole idea behind this trade is that the near dated option (Dec 2010 50 CALL) will erode much faster than the further dated option (Jan 2011 49 CALL). The net Theta for this trade is therefore positive. The snapshot analysis shows that your break-even prices (at Dec 2010 expiry) are 48.78 and 52.39. Thus you make money in this trade if WFMI trades below 52.39 and above 48.78 by Dec 17, 2010. The trade makes maximum profit if WFMI is at 50.00 (the strike price chosen for the near-dated option).

Another way to look at this trade is that if WFMI trades below 50.00 strike price by Dec 17, the Dec 50 CALL that you are short will expire worthless. You will then have the Jan 49 CALL to participate in further upside in WFMI.

Less than two hours ago, General Electric (GE) announced that it has raised its dividend to 14 cents a share, an increase of 17% from the 12 percent it had been offering.

GE CEO Jeff Immelt said “We are able to increase the GE dividend for the second time this year because of continued strong cash generation, accelerated recovery at GE Capital and solid underlying performance in our Industrial businesses through year-end 2010.”

This news definitely helped GE shares break out above resistance. One can expect GE shares to test the 52-week high of 19.70 in the not-so-far future. Bullish investors can keep an eye on its price action and may go long GE shares with stop loss below the breakout price of 17.50 or so.

– DevTrade (Full Disclosure: Long GE calls at the time of writing)

Even since reaching a 52-week high of 19.86 back in April of 2010, Bank of America (BAC) shares have severely underperformed the broader market, falling by more than 30% in 8 months. The 50-day moving average has been a strong resistance for the stock (and provided great opportunity to short). However, today the stock broke above it 50-day moving average of 12.04. This will now be the new support. The stock also shows a double bottom at the 11-level. If BAC shares can breach the 13-level, the downtrend will also be reversing course.

Investors bullish on BAC can go long with stop-loss underneath the 50-day moving average. The February 2011 12.00 strike calls look attractive.

DevTrade (Full Disclosure: Author long BAC Calls at the time of writing)

I have been a big fan of Chipotle Mexican Grill (CMG) for a long time. I have consistently liked this name from the 140-level. The fundamentals for this company are really strong, there is tremendous growth opportunity, and the long-term chart shows a very strong up-trend. One problem with this stock is its *spicy* valuation compared to its peers.

After reaching a life-time high of 262.77 earlier this week, CMG has pulled back more than 10% in the past couple of days. This morning Morgan Stanley downgraded the stock to Equalweight from Overweight.

The Bullish Picture:

The stock has short-term support at 225-230. It seems like the support is holding at the time of writing (3:00 PM). It bounced back slightly after reaching an intraday low of 231.00. A bullish investor can get long CMG shares at this price with a stop-loss underneath 225.

The Bearish Picture:

Given the fact that the stock had a huge run up since it reported blowout earnings on Oct 21, 2010, it is not unlikely that the stock may trade sideways or down from here. If the stock falls through the short-term support, it might trade down to the 200-level.

Additional Note:

I would also like to note that the options of CMG have high bid/ask spreads. So if you are using options (especially any sort of spreads, e.g., vertical spreads) please use limit orders.

(Full Disclosure: Author has no position in CMG shares at the time of writing)

Ford (F) has seen a great support in the 16-area over the past few days and bounced nicely off of the 20-day moving average yesterday. From the fundamental point of view, it is in a great position, led by its great CEO Alan Mulally.  Ford’s unit sales have surged 21% so far this year compared with 2009 to easily outpace the broader industry’s growth rate.

I expect F to challenge its 52-week high of 17.42 in the near future. Investors with longer time horizon can go long F shares at this point.

If you believe that F can run up to the 19-level by Jan 2011, you can buy the Jan 2011 16/19 CALL spread for 1.10 debit. This trade risks 1.10 for a potential profit of 1.90 by Jan 2011 expiration (~170% return in 50 days) if Ford shares jump 13% from the current level in that timeframe. The break-even price is 17.10 on Jan expiration.

(Full Disclosure: Author long F shares at the time of writing)

Whole Foods Market Inc. (WFMI) reported better-than-expected earnings on Nov 03, 2010, and raised its full-year guidance. The stock gapped up almost 10% next morning and then rallied to an intra-day high of 48.02 (which is also WFMI’s 52-week high). Since then, the stock has been trading sideways in a very narrow range, creating a volatility squeeze (please refer to the attached chart of WFMI; source: StockCharts.com). In the mean time, the 20-day moving average has also moved higher to 46. The charts indicate that WFMI is poised to make a big move either way. I believe that it moves higher if it can break above the 48-level. The fundamentals also line up quite well as more and more people are becoming conscious about what they eat. The US economy showing some consistent improvement could provide the next boost.

I believe one can take advantage of this by going long WFMI. I would also recommend a stop-loss at 44.75, which is just below the intra-day low on Nov 04, 2010.

(Full Disclosure: Author long WFMI shares at the time of writing)