Last night, I logged onto Jim Brown's talk regarding the selling of put LEAPS and buying protective puts as a relatively low cost way to benefit from an upside move in the underlying security. Immediately I thought of the Biotechs and our current play for 1/2 position long in the July 130 calls for the Biotech HOLDRS. If I thought the BBH looked strong on May 17th on a break above $132, then wouldn't this type of security fit what Jim spent 2- hours on last night? I think so and I'm going to take action today.
But! Now I'm going to also add a nice little twist that will perhaps blow everyone's mind. You know how I've been introducing subscribers to point and figure charting and some of the different techniques an options trader should be incorporating into their trading strategies? You know, the vertical count , the buy and sell signals? Heck, what about that thing called trend (bullish support and bearish resistance). Many of those items are an options traders friend! Here is how were going to use the power of point and figure charting in our option strategy as Jim Brown outlined last night. We're going to use the vertical count and potential bullish price objective to help us establish what put option a trader might want to sell, and also use the point and figure chart to establish the offsetting protection for buying the protective put. We're also going to ascertain trend and see if we should even be thinking about a bullish strategy at this time. Here we go!
Biotech HOLDRS (BBH) - $1 & $2 box
Let's see. The BBH has broken above its long-term downward trend (bearish resistance and red +). The chart pattern has given a triple top buy signal at $130. The new overriding trend is not up (bullish support at $102, blue +) and the vertical count gives us a bullish price objective of $196. Is that bullish? I'd say so. First sign of trouble on the chart comes with a trade at $118 which would be a double bottom sell signal and a point where the current vertical count would be invalidated at. So, now we have a target and a hedge point to consider when putting our strategy into place. Let's take a look at the BBH option chain and what a trader might consider doing going forward.
Point and figure charts were made for longer-term investing. Charles Dow wasn't a day-trader, but he was interesting in what supply/demand had to say about his investments. While I like to use point and figure charts as part of my day-trading arsenal for establish longer-term price targets as well as giving me an institutional perspective on the stocks I trade, the point and figure chart along with Jim Brown's webinar discussion for selling deep in the money puts and buying a protective put looks to mesh together nicely.
Option Chain for BBH on 05/20/01
I've grouped together the four options a trader might want to consider for such a strategy. Depending on the subscriber's investment time frame, I'd consider the $180 strike as a strike to sell (based on the vertical count from the point and figure chart) and then consider the $130 put or $120 put as my protective put option should the trade begin to fail. Depending on how much "insurance" you want to buy in the protective put you can see how the point and figure chart once again comes into play. Note the triple top buy signal and breaking of long-term downward trend at $130. Hey! That protective put for July $130 fits real nice. Also consider the sell signal that would occur at $118 on the point and figure chart, invalidating the vertical count. Hey! That $120 put would help hedge risk there wouldn't it?
Doing the math
Let's say we think the Jan03 180 put (OEEMP) interests us and we think the BBH might be able to trade near $180 in January 2003 considering a bullish price objective of $196. If we were to sell 1 contract, then an account would be credited $5,650.00 (1 contracts x 100 x $56.50). If we were to play it "safe" and then buy 1 Jul 130 put (GBZSF) our account would be debited $900.00 (1 contract x 100 x $9.00). Net to an account not including commissions would be $4,750.00. Maximum risk in the trade until July expiration would be approximately $900.00 plus the difference between a purchased put option and Friday's close of the BBH at $133.26 (133.26-130.00= $3.26 x 100 = $326.00) or 1,226. Break-even for the trade as outlined with these two options would then have to have the BBH trading at ((Risk / 100) + 133.26) or $145.52. If a trader thinks the BBH will trade above the $145.52 level by July 20th and at or above the $180 level by January 2003 then he/she may find this trade to his or her liking. We've used 1 contract as an example, but a trader could now calculate different risk/reward number using different trade sizes as they see fit.
Stock/Security selection is key to any strategies success
One thing I feel the need to point out to any trader is how important stock/security selection is for a trade to have a chance at being successful. It's easy for eyeballs to grow big when they begin looking at some of the premiums found in the above strategy for various stocks. For this strategy to provide the desired result (this is a bullish strategy), I'd suggest the trader be honest with themselves and the stocks they look to implement these types of bullish strategies on. Is the stock or underlying security currently showing that demand is in control? Is the bullish price objective of the underlying security in line with the put being sold? Is the stock in an up trend or still in a longer-term downward trend? We are all here to make money in the short-term as well as the longer-term, but the "current environment" often times helps remove some of the longer-term uncertainty. True, what is popular today may not be what is popular in the future. But if a trader is at least exposing their capital to areas of the market that look to be breaking long-term downward trends, giving buy signals and have enough upward bullish indications, these are perhaps the groups of stocks that institutions are currently putting money to work in based on price objective they too are targeting. While Cisco Systems (NASDAQ:CSCO) at $20 looks attractive for a LEAPS put play, it may be a stock that takes time for the trade to become profitable in. I'd encourage every trader/investor to simply use some of the techniques we have taught in past commentary to truly ascertain where there money is best invested in the current market environment and not put all their eggs in one basket.
How would the BBH strategy be acting?
The above commentary was written last night. Here's a very short-term look at how this strategy would currently be looking with the BBH bid at $53.40. Remember, this is a longer-term investment strategy that we've outlined with an offsetting put to help hedge the trade in case of a decline in the BBH.
Updated BBH position to show dynamics of trade on upward move
PremierMarkets.com has not profiled this as a play in our profiled portfolio strategy as we had already profiled a bullish call play in the BBH. However, this is an example of how last night's Webinar and discussion of LEAPS puts might be implemented and what to expect in the early going of a trade. The above hypothetical was based on 1 contract of each security. The negative numbers under "Value" indicate the credit associated to a traders account, but do not reflect commissions that would have been paid. Subscribers may have different commission schedules, but you can now better understand how this trade progresses over time and at what point the trade might result in an unrealized profit or loss. Every trade is "unrealized" until the trade is closed.