The Buffett trade last week produced so much positive email I am going to continue adding low risk, high reward plays that are outside our normal profile.
Everyone seemed to like the free play on Bank of America last week. To refresh we bought a 2013 $7.50 call and sold a 2013 $7.50 put to give us a nearly free ride for the next 16 months. If the economy improves Bank of America could be double today's prices and we would have a home run that cost us nothing.
Several readers that missed the entry point on the 26th has asked if they should move up to the $10 strikes instead of paying the extra premium to enter the currently in the money call strike at $7.50. I don't like that risk-reward as much as the $7.50 strike. The $10 put strike is definitely worth more money at $3.20 today but the $10 call strike is still $1.40.
There are two ways I would consider changing the original trade for late arrivals. You could sell the $10 put and buy the $7.50 call, currently $2.54 and have 70-cents left over. That call is already in the money and odds are very good BAC will be well over $10 a year from now. Anything over $10 is a profit and the risk is still minimal but it does require BAC to be over $10 in 2013.
The second way to change the play if you are feeling a little more aggressive would be to sell the $10 put and buy TWO $10 calls, currently $1.44 each. You still have a small net credit at initiation but you are doubling your upside with the two calls. Unfortunately your upside does not start making money until BAC is over $10. If BAC returns to resistance at $15 then your put expires worthless and your calls are worth $5 each for $10 total. That is not a bad deal for a free trade but your profit threshold is $2.50 higher than the play I recommended last Friday.
Personally I would have no problem with either version because I feel very confident BAC will be back at $15 or higher by Jan 2013. Of course that assumes no double dip recession and the end of all the mortgage litigation for BAC. The bank is making money but it has to plug the mortgage leak in order to move higher. I believe they are doing that.
I added two similar plays tonight.
Current Position Changes
New Short Put Recommendations
New Covered Call Recommendations
New Long Term Recommendations
MDR - McDermott Intl $14.40 (Combination)
McDermott moved lower with the decline in oil prices but it was crushed in early August when earnings fell short of expectations due to a decline in business activity in the Middle East. Several projects in that area were completed and others were delayed by the civil unrest in places like Egypt and Libya. That problem is behind us now and McDermott is in rally mode.
The long-term view is for a return to the $20-$22 level over the next six months. I am going to recommend selling the January $14 put and buying the January $15 call with each side at $1.70. The trade will cost nothing to enter and any move over $15 is pure profit.
The downside risk is that MDR closes under $14 in January and we either have to buy back the put for a loss or be put the stock at $14. I believe that is an excellent trade off and I am willing to accept that risk.
Buy MDR Jan $15 Call, currently $1.70, no stop, target MDR @ $20
Sell Short MDR Jan $14 Put, currently $1.70, stop $13.
Chart of MDR
BZH - Beazer Homes $2.11 (Combination)
Yes, the homebuilding sector is in the tank. Yes, the near term outlook is not good. However, the long term outlook is outstanding simply because there are very few homes being built. The overhang of foreclosures is depressing prices but there are some moves underway to start converting those foreclosures into rentals to take the pressure off the market. Regardless of whether that happens the sector should improve as current inventory continues to decline and the steady but slow stream of new homebuyers puts upward pressure on the builders to produce new homes. This is a play on a grossly oversold builder and the assumption we don't fall back into another recession. That risk always exists but the risk on this play is minimal.
Beazer Homes is the eighth largest U.S. homebuilder. They have highly diversified operations in 16 states. Their primary focus is on entry-level homebuyers in the Southeast and Mid-Atlantic states. Their average price point for a starter home is $213,000.
They have $275 million in cash and their market cap is only $160 million. On the surface that would seem to be a slam-dunk but they have $1.5 billion in debt that is due in 2015. This is on land purchases and existing inventory.
Citigroup put out a positive report on Beazer last week saying they should be able to outlast another three years of housing weakness thanks to their large cash hoard even if prices continue to fall.
The largest single stockholder is John Paulson at 7.8%. Also renowned investor David Tepper of Appaloosa Management just bought a big stake in Beazer.
At $2.11 per share the risk is so minimal it is ridiculous. That is less than the cost of a normal option. You could always just buy the shares but I am going to recommend a free play on BZH.
I am going to recommend selling the January 2013 $2.50 put, currently $1.05 and buying the January 2013 $2.50 call, currently 75-cents. We will make 30-cents on the trade up front and we have a free ride until January 2013. Anything over $2.50 is a profit plus the 30-cents in excess premium received. The risk is Beazer staying below $2.50 in January 2013 and we would be put the stock at that $2.50 strike making our cost $2.20. The upside "could" be a return to $5.00 and a huge return percentage wise. If the economy actually began to really recover we could see a windfall return.
Buy BZH Jan 2013 $2.50 Call, currently $75-cents, no stop, no target.
Sell Short BZH Jan 2013 $2.50 Put, currently $1.05, no stop, no target.
Chart of Beazer Homes - 90 Min
Chart of Beazer Homes - Monthly
New Aggressive Recommendations
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)
Prices Quoted in Newsletter
At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.
The prices quoted in the newsletter are the end of day prices in most cases.
When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.
For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.
For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.
All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.