Monthly Cash Machine Newsletter, Thursday, 05/26/2005 04:03:16 AM ET
Trade Alert - TORO
HAVING TROUBLE PRINTING?
Toro Gets Trimmed!
Shares of Toro (NYSE:TTC) fell sharply Wednesday in a second consecutive session of bearish activity after the company's quarterly earnings report. Trading volume was nearly four times the daily average and the small amount of buying pressure was overwhelmed by a series of block trades as market-makers struggled to maintain order during the sell-off. The only good thing that can be said about the downside move is that it ended a few cents above the suggested stop-loss price, allowing MCM Portfolio readers some extra time to develop a viable exit/adjustment strategy. While we suggested that conservative traders might want to initiate an early-exit during the morning session, there was some optimism that a support area would emerge above the sold put strike price at $42.50. As the day wore on, that hope was all but forgotten and the stock now appears poised to test the low $40s in the coming weeks.
Since our primary goal is to limit the losses from the trend reversal, we are going to consider two possible exit/adjustment strategies that may achieve that objective. The first technique is simple: close the short (JUN-$42.50) puts at the current price and hold the long (JUN-$40.00) puts in expectation of further declines in TTC's share value. However, there is a problem with this strategy. The small amount of time-value remaining in the (JUN-$40.00) options requires a relatively large move in the underlying issue to significantly affect their value. With only three weeks until the June expiration date, the stock would have to decline another $2-$3 before the (long) puts could be sold for a profit.
Another method is to transition to a bearish credit spread with a slightly longer time frame and a higher probability of a successful outcome.
The existing position is:
Long JUN-40.00 PUT TTC-RH BID=$0.30
Short JUN-42.50 PUT TTC-RV ASK=$0.85
INITIAL NET-CREDIT = $0.25 (X 10 contracts) = $250
CURRENT MARGIN REQUIREMENT (X 10 contracts) = $2250
COST BASIS = $42.25
Based on Wednesday's (last) prices, the exit trades are:
BUY (10) JUN-42.50 PUT TTC-RV
SELL (10) JUN-40.00 PUT TTC-RH
at a net-debit of $0.50 per contract or better.
Total cost = $500 plus commissions
Realized loss = $250 plus commissions
If you can accept a $250 debit in the position, then do nothing else with regard to the TTC spread. Simply move on to the next candidate and plan to offset the loss with gains from another winning play.
However, if you want a little "pay-back" and you believe (as we do) that TTC has little chance of moving higher in the next six weeks, you can:
BUY (15) JUL-55.00 CALL TTC-GK
SELL (15) JUN-50.00 CALL TTC-GJ
for a net-credit of $0.20 or better.
Total profit = $300 less commissions
Potential (overall) gain = $50 less commissions
Collateral requirement = $7,125
Days until expiration = 51
Keep in mind, the margin required for the new position is sizable but it is far lower than the collateral necessary to sell the same number of "naked" calls. In addition, the long call options (at $55) afford some level of protection against a catastrophic upside move, regardless of how improbable such an occurrence might be. At the same time, readers should understand this method is only one of many alternatives (including exiting the spread for a small loss) available to option traders. It is not necessarily the best strategy to remedy the current situation, but it may be a viable choice for those who have adequate portfolio capital and a desire to recover lost profit potential using a current (known) portfolio issue that has demonstrated a technical/fundamental change in character.