Option Investor

Option Writer Portfolio - August

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Chipotle Mexican Grill (CMG) engages in the development and operation of fast-casual, fresh Mexican food restaurants. CMG operates independently of McDonald's Corp. as of October 5, 2006. Fast food isn't normally concidered a luxury item but the stock has been on a decline from its peaks at around $155 a share on December 31st. I am admittedly a big fan of the food so I might be biased thinking that people will replace eating at nicer sit down resturants with eating a fancy burrito or taco at Chipotle. The tomato and vegatable scare may have contributed to the recent decline. But know one knows for sure where the tainted food is from. Plus CMG raises much of its own livestock and vegitables it uses. The truth of how much food inflation has affected the earnings will come out in the earnings on July 23rd.

We are selling only one contract for the August expiration cycle since we are able to reach our profit goal with only one. The extra premium for 10 points out of the money is from the earnings implied volatility. The trade should require about $600 to initiate. Remember that if you have more capital that our hypothetical $50,000 account that you should adjust the quantity up. Also you should be able to do the number of contracts and positions we send out each month with about $15,000 to $20,000 of capital. Even with being $11 out of the money this position still carries 3 times more risk than our 10% minimum return requirement suggests. If the stock drops we still have capital to sell more contracts if that option is necessary. The target is to sell the put option for $2.10 to $2.15. Or for twice the margin we can sell twice the number of contracts of the August 55s for roughly $1.10 each. Same max return in dollars and twice the cost of capital. But we do gain $5 more points of downside protection.

The downtrend line takes CMG's potential move to support near $60. The $63.91 is the support established from a low on May 1st, 2007 on the day prior to the gap up that established the beginning of the breakout run. The breakout occurred by establishing a $68 gap high that is targeted to be filled on weakness. A fill of the $68 gap may cause me to sell one more contract. The technical risk management level is at $63.91. The cost basis stop is at $57.90 or so. If the stock breaks below $63.91 then I will wait to see if the price touched the downtrend line before selling the $55 strike.

The chart above shows what I am looking at in regards to Bollinger bands, RSI, Stochastics and the 8 and 21 day EMA's. CMG is basically oversold according to RSI's tick up on Friday. Slow Stochastics is indicating that CMG is also oversold but not yet confirmed a re emergence out of that territory as RSI has done. The 8 day EMA (magenta line) has served as the resistance for the downtrend. So a close above that would be good to see. A run to the 21 day EMA (green line) will prompt to sell the calls. Good trading to all. It's a crazy day so far.

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