Tiffany (TIF) - Get Report shares rallied Thursday in reaction to the company's earnings report, but shares won't maintain Thursday's gains, and you can use stock options to profit from the coming move lower. The price gapped higher Thursday, but the chart now looks bearish.
The big gap is of concern because it moved above resistance. At the same time, price has formed a rising wedge during the month of August. This is a bearish reversal signal. It is further confirmed by a strong volume spike and momentum moving into overbought territory. (Relative strength index readings of more than 70 indicate that a stock is overbought.)
Tiffany shares traded Thursday at $73.28. If you own shares, this creates a question. Do you sell shares to take profits? Or is there another way? Look at the Sept. 9 options, which expire in 14 days. Stockholders can exploit this strong price move with a covered straddle. This combines a short call option with a short put option, both out of the money. It is a conservative strategy, even though both sides are short. The call is covered by the shares of the underlying stock, and the short pout has the same market risk as a covered call.
The Sept. 9 options can be used to set up the straddle with the following trades:
Sell 73.50 call, bid 1.38, less trading cost = $129 net
Sell 73 put, bid 1.09, less trading cost = $100 net
This position yields $229 with 14 days of exposure. It relies on rapid time decay so that both sides can be bought to close at a profit. Depending on how the stock price behaves, either side can be closed to avoid exercise or rolled forward. But even with the close proximity of the strikes, time is on the side of the seller.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
Besides blogging atTheStreet.com,Michael Thomsett alsoblogs at Seeking Alphaand several other sites.He has been trading options for 35 years and has published books with Palgrave Macmillan, Wiley, FT Press and Amacom. His latest book is Making Money with Option Strategies.