Last month, my
Going Away, but Retuning to a Different PlaceThe last time I mentioned back spreads was more than a year ago in
Backing EMC Into StorageThis time, let's use January 2005 calls, which give us a nine-month time horizon (making the options still technically LEAPs). The premise is that the expanded time period will not only allow for a more substantial price move, but also the likelihood that implied volatilities will have lifted off of their eight-year lows. EMC ( EMC) strikes me as a good candidate for establishing a call back spread. With shares in the data storage company trading at $11.75 on Wednesday, one possible back spread would be to sell one January 2005 $10 call for $2.60 per contract and buy two $12.50 calls for $1.25 each (a total of $2.50) for a net credit of 10 cents, or $10 a spread. (Consider this an even-money position when the cost of commissions is included). The table below shows the costs as well as the profit and loss for various price points in EMC at the January 2005 expiration. Note that it makes no assumptions about changes in implied volatility. While EMC is getting beaten down in an out-of-favor group, it remains one of the best-run companies in the sector, and it doesn't seem unreasonable to believe the stock could double in the next nine months.
|EMC Back Spread |
|Values with EMC at Various Prices|
|Sell 1 Jan. $10 Call||$2.60||$0||($2.50)||($5.00)||($10.00)|
|Buy 2 Jan $12.50 Calls||1.25x2=(2.50)||0||0||5.00||15.00|
|Source: TSC Research|