Options for Making the Market Bearable

Even though my thesis has been wrong so far, with the spread between Home Depot and Lowe's widening from $14 to $16, the option position is currently showing only a 30-cent loss. But now, with just one month remaining until the short Lowe's calls expire and two months remaining in the long Home Depot calls, the position's leverage is squarely in our favor. The risk of Lowe's running much further than Home Depot diminishes as the clock ticks.

A similar example in which the desired move hasn't yet played out, but where the position's risk/reward keeps improving, is the calendar spread for homebuilder Lennar (LEN Quote). On Nov. 13, with the stock at $51, my example involved buying the May 45 put and selling the December 45 put for a net debit of $3.35. The notion was that the stock would work its way lower over the next six months.

A key element to this strategy was that if the stock stayed above $45 as the near month expired, we would roll the short puts into the next nearest month, thereby reducing the cost of the long May puts. Lennar has traded between $48.20 and $57 since then. Unfortunately, the dips didn't coincide with option expiration. So unless you had extraordinary timing, you would've been selling the January, February and March 45 puts with the stock at an average price of $53, receiving about $1 for each put.

Still, that means we've taken in another $3 in premium, bringing the cost of the May puts down to just 55 cents. With Lennar trading at $53, one can sell the April 45 put for 80 cents, and that makes this a no-cost proposition.

Learning Patience

Nailing down a reasonable oil strategy was a bit of challenge. So far the idea of selling the bearish April call spread against selling a bullish June put spread is working. Again, the maximum profit will be realized if April oil goes out under $35 and June oil closes above $31. Considering the volatile nature of the market, I'd stand pat with this position.