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GT: Let's Roll

The Goodyear Tire and Rubber (GT - Get Report) is an interesting stock to watch. It has some positive fundamental influences. Its price to raw material cost outlook is improving as recent price increases are likely to offset inflationary pressure. Dealer inventory levels more normalized after over supply. And its exposure to replacement tires is attractive.

It's underperformed the broad market and had a strong pull back yesterday. Technically, this looks to be a level to scoop up some shares at historical lows. Accumulating GT shares between $10 and $12 a share could make for a nice longer-term play.

Let's review the T3/OP video with Jill and Scott for more of a fundamental and technical look into GT and a quick update on SPX levels:






The problem is that this low-priced stock has some relatively expensive options. To play this right, traders need to look for a spread strategy that stacks the odds in their favor, and one that hedges off the high cost of options in terms of implied volatility.

One way to play this set up is with a diagonal.

Trades: Buy to open GT January 2012 10 calls for $1.55 and sell to open GT November 2012 calls at $0.30.

This is a two-legged trade. Each of the two legs brings something a little different to the party. The January 10 calls are the meat and potatoes of the trade. It provides the positive delta (that is the bullish directional exposure) with the safety of limited risk.

The November 12 calls help offset the cost of the January 10 calls. They reduce the cost by 20%. The position in the November 12 calls asserts that though the trader is bullish, he believes GT might not get above $12 a share in a big hurry. And if it does, it might be a good place to take some profits off the table, selling the January 10 calls on upside appreciation.

Volatility:

With implied volatility around 70 in these options, buying a call outright is precarious. If the broad market settles down and volatility wanes, the January 10 calls stand to lose a lot on the vol crush. The $0.30 brought in by selling the November calls can make up for that potential loss.

Theta:

Theta (or the spread value's sensitivity to time passing) is about flat or somewhat positive here (positive theta being beneficial). As GT rises, the spread's theta should become even more positive, benefiting the spread value as time passes.

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