Premium Post for 6/7/2009

• stevenplace
• June 7th, 2009

Good evening everyone, hope you are all well rested and ready for the trading week.

This is my favorite time of the options expiration cycle. Two weeks before expiry and the time decay really starts to kick in and selling strategies start to show whether they were worth the whipsaws over the past 4 weeks.

The only problem we have with selling strategies is that levels of volatility are not high at all, relative to what they were over the past few quarters. But while we consider what sort price movement we are to expect for the next few weeks, we have to keep this in mind: the levels of implied volatility we have in the present would have been panicky levels back in 2007. If you were trading options back in 07 and late 08, these levels of premium would have been “fat”– and if you sold vega into October you would have been hurting.

So in terms of volatility outlook and what sort of vega risk should we be taking on? Well I think it’s a mixed bag and we should consider each trade independently and then consider whether it’s appropriate for our portfolio. And for our premium subs, I’ve got a variety of strategies to take advantage of certain technical levels to help you gain an edge in this market.

Premium subs, the trades for Monday are below the fold – make sure you sign in to see them!

With respect to market outlook, we need to keep a keen eye on whether the dollar rally we saw on Friday will continue into the next week. If it continues its countertrend move, we should expect further weakness in commodities and related names. I’m looking to buy pullbacks in certain uptrending etfs and stocks, with energy definitely on my list.

Ok, first trade of the week:

Sell FSLR 210/175 Strangle for 7.50 or better

This trade is relatively straightforward: FSLR has been stuck in a range and is currently at the lower end of it. The price area between 175 and 180 has been a clear area of demand in the name and we are assuming that it will continue to be so. Since it is in a range we can also assume that within the next two trading weeks it won’t break above 210 anytime soon.

Two risks come to mind here: first, we’ve been making lower highs for the past month which could be indicitave of a trend change if it breaks 175. Second, we have that huge earnings gap that could lead to a large rush lower if downward momentum comes into the name. So we need to keep our stops tight on this trade, namely below that green line.

Here’s the risk profile:

As you can tell this is a bullish strangle (initially) with breakevens at 167 and 217. Those two levels encapsulate the month long range with a little bit of wiggle room. I’d put a lower bound initial stop at 174.8 – we do not want to have positive delta on a potential breakdown! So if it were to get stopped out tomorrow you’d be looking at a loss of $200 (I rounded up) per strangle– that improves as the time decay wastes away that extrinsic value. The max gain is 750 so you’re looking at a 3.75R trade.

Also you’re looking at about a 65% chance of success via the probabilities, but I think the technical range we’re in gives it a bit higher odds.

Now with the dollar up we could be facing a bit of a gap down on the open on Monday. If we open below 175 wait for the first hour to see if we regain that channel based off agressive buying. If the price doesn’t move around, the trade is a no go.

One more thing, the options might have a bit more extrinsic value pulled out of them when the chains open, and I’d be willing to sell at a lower price, but I’m looking for at least a 3R trade or better.

Next!

Buy ILMN Jul 40 Calls for 165

Simple breakout play.

Stock has been knocking on 39 for 2 months now, the moving averages have caught up with price. If you look at the daily Bollinger Band (not shown) it’s starting to open up. I’m looking for a price and vol expansion, hence buying calls. I’m putting my stop below 36, so you’re looking to risk about $95/contract.

In terms of position size, I’d work in groups of 3′s. So we’re risking 95, we’d need the stock to get to 40.5 to hit 1R. I’d take a 1/3 off right there– that will help with your risk management and overall expectancy. Do note that since we are buying options here, I’m looking for the contract to double or triple in value by the time we exit. If you don’t think that 43 is a feasible price target for this trade, then don’t take it.

That’s all I’ve got for tonight, I’ll be putting up some more trades throughout the week as we approach certain price levels. If you have any questions just email me at steven@stocktwits.com.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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