Have Your Cake and Eat it Too
In the world of option trading, there are two main types of trades: speculative trades that make profit based on a predicted price move, and income trades which rely on the decay of insurance premium. At
OptionPit.com
one of our favorite trades combines both of these, we like to call this trade a "spincome trade." These are trades that will make money if nothing happens, but will do better if the trade makes a predicted price move.
A trader in Sara Lee (SLE) initiated a type of spincome trade this morning. With SLE trading around $14.65, the trader sold the November 14 puts about 12,000x and bought the December 14 puts against them. The company is scheduled to report the quarter before the open on November 10. Consensus expects EPS to come in at $0.17 and for SLE to post revenue of $2.48 billion. The stock hit a 52-week high around $15.00 in early August, but came under pressure, as did the entire food industry, due to concerns over rising input costs and promotional activity. Furthermore, SLE is engaged in an internal and external CEO search which does not help matters.
This trade will do extremely well if earnings are mildly poor and the company drops about 5%. However, if the stock sits somewhat still, even after I eyeballed changes in front and back month volatility, this trade will profit up to about $14.80 and down to $13.30. This risk associated with price movement in SLE is that the company has seen private equity interest, according to an article from the New York Post on October 4. Long term, management is also committed to to buying back stock equal to 25% of the market cap over the next few years, which could provide support.
That being said, I love the risk/reward on this trade, the spread can be purchased for less than $0.25, but traders should be able to exit for $0.10-$0.15 if the trade goes awry. Thus, I see the true risk for a disciplined trader at around $12.50 per spread. If Sara Lee does drop toward $14.00, I think traders could see a raw return of at least 50%, which is a 100% return on the capital we intend to actually put at risk.
Trade: With SLE trading at $14.65, sell to open SLE November 14 puts at $0.20 and buy to open SLE December 14 puts for $0.45.
At the time of publication, Mark Sebastian held a position in the trade described.
Mark is a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange, and is currently the Director of Education at The OptionPit.com and the Director of Risk Management for a private hedge fund. Mark also writes Option911.com, a popular index and equity options blog.
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