Option Investor

Portfolio Activity - COP

Printer friendly version

Position Management: The COP Spread

Earlier today we outlined the basic components of an adjustment in the Conocophillips (NYSE:COP) position. In order to post the alert in a timely manner, the description of each trade provided only the minimum information necessary to make the transition to a neutral-outlook calendar spread. Now the market is closed, so we can review each step in the process and explain the outlook for the new position.

The original "bear-call" credit spread, offered on 5/22/05, included these trades:

BUY (5) CALLS JUN-115.00 COP-FC ASK=$0.25


SELL (5) CALLS JUN-110.0 COP-FB BID=$0.65

at a "target" credit of $0.45 per contract.

During the next few sessions, the combined position was observed at the suggested (net) price. Thus, the maximum gain from the spread was $225 ($0.45 X 100 X 5) and the break-even point was $110.45. Given the previous lateral pattern in COP, we decided to use a "covering" technique to minimize losses (and possibly profit) from future upside activity. The initial exit strategy was outlined in the original play narrative:

We intend to transition to a horizontal (calendar/time) spread if the issue moves back into the intermediate-term lateral pattern near $108. Readers who want to pursue this strategy should enter a contingent "stop-market" order to purchase five (5) contracts of the AUG-$110 call options (COP-HB) if the stock trades above $109.25 on an intraday basis.

As it turned out, the broad retreat in oil-related issues ended soon after the position was offered and earlier today (6/1/05), the rising stock price triggered the first trade in the exit/adjustment process. Based on the time and sales data for the session, the cost to buy the AUG-$110 calls was $4.80-$4.85 per contract. After that purchase, the existing positions were:




Since the AUG-110 calls provide an equivalent "cover" for the JUN-110 calls, the original long position (JUN-115 calls) can be sold to reduce the cost of the new spread. Although adept traders may be able to achieve a higher credit, we suggested a price of $0.45 or better (per contract) to assure the timely sale of these options. Readers who initiated this order would have been "filled" during Wednesday's session, thus reducing the debit for the adjustment to roughly $4.40 per contract. In addition, a credit of $0.65-$0.70 per contract from the original short position (JUN-110 calls) can now be applied to the basis for the new spread, further reducing its overall cost. Consequently, the current cash outlay for the AUG-110/JUN-110 calendar spread is approximately $3.75 per contract or $1,875.

So, what's our objective or "where do we go from here?" Ideally, the stock will move laterally in the coming weeks, allowing the sold (call) options to expire. Then we can sell additional call options against the long position to further reduce its basis. Remember, the advantage in a calendar spread is that time erodes the value of the near-term option at a faster rate than the far-term option. However, a large directional move will reduce this effect, thus it is necessary for the underlying issue to remain in a relatively small range to maximize profit potential. Although additional adjustments can be made to accommodate unexpected volatility, the best possible outcome is for COP to end the June expiration period where it is right now, near $110. Our analysis suggests there is a high probability of this outcome but considering the recent gyrations in the oil sector, it may be an unreasonable expectation. Only time will tell...

MCM Staff

Monthly Cash Machine Newsletter Archives