Trade Setups, 9-8

• stevenplace
• September 8th, 2009

FCX

Trade Rationale: Overall in an uptrend, but has been stuck in a range between 60 and 66 for past month. With gold and copper strong, I expect this name to continue its uptrend on a breakout. Volatility is fairly priced according to the historical vol, but I’m expecting absolute price movement to expand, with the Bollinger Bands opening up.

Trade Strategy: As we are bullish on direction and volatility, I don’t mind a simple call buy strategy, keeping the strategy on the short term. I’m trading the Oct 70 Calls. The premarket bid on FCX right now is at 6817, a significant gap up, so that would put the current contract price at 3.98.

Execution/Risk Management: In terms of overall position size, I will not take on more than 5 contracts, which means I’m looking to deploy no more than $2500 worth of capital. Because we are at such extremes in the premarket, I will not put on a full position; rather, I feel that a pullback to 68 would make for a much simpler entry at a better price for the call option.

I do realize the possibility of a runaway gap for the next few days, so if we open on FCX and we are strong, I will buy3 contracts with very tight stops– essentially if we don’t have strength in the name through 1030 then I will exit and wait for a fill at 66.

Because this is a post holiday open the option pricing is going to be a little stupid so I’ll wait for first 10-15 min before executing a trade.

If we get the pullback to 66, I will use Thursday’s LOD as my stop loss. If we do not close higher above the first std. dev. of the Bollinger Band (blue line), I will cut position by 2 contracts.

UNG

Trade Rationale: Poleaxed. That’s the appropriate technical term for how UNG has fared over the past several weeks. Any attempt at bottom picking has been met with further drawdowns. The long oil, short natty play has been a hedge fund favorite and that spread has hit unprecedented levels. But what’s more interesting is the level of implied volatility that has come in the name. Is the IV spike warranted as the structural issues and demand for natural gas come into play? Or is it fadeable? I think the latter is the right play here.

Trade Strategy: Since this is a knife-catching play, we don’t want to have unlimited exposure to the downside. So we are moderately bullish… not even bullish, it’s a bearish play on volatility; we’re assuming that price will not go down as fast as what the options are pricing in. So I will be implementing a bull put spread strategy. Sell UNG Oct 9/7 vertical for .55 – .65.

Execution/Risk Management: Since my overall risk is fixed, I will use that as a natural stop. I may exit out if the trade doesn’t “feel” right but I’m comfortable with accepting full risk, which is 140 per vertical. I will be using 4 total verticals with a risk of 560. UNG is currently up premarket so the fill may not be there, and if it isn’t, I won’t fill.

XME

Trade Rationale: This ETF has been the trade I’ve been stalking for quite some time. About half of the components are precious metals, and the other half are steel names. Any sort of dollar weakness and global growth combination will spark this trade higher.

Trade Strategy: Premarket shows that the name has already gapped through that resistance. I will not chase this name; instead, I will focus on individual names to chase on strength intraday. I will be looking for a pullback to the breakout level of 43.15. There’s a variety of option strategies to consider on this play, but we do come into some big levels of resistance at about 50/share, so I feel that the fast move is going to come between now and that level. Because of that thesis, I will be looking at a bull call spread, namely Dec 44/47 Vertical for 1.20 or better.

Execution/Risk Management: The options in this name are not the most liquid and the bid/ask is .20 wide in some cases. I would strongly recommend not to use market orders and be patient with your fills. Since this is a sector etf, the market makers should be rather cooperative.

In terms of position size, I will be looking for exposure to 5 contracts in the 40k. That means a total capital outlay of about $600. This gets us effectively long 60 shares of XME with about 3.5x leverage. I will be keeping wide stops on this as it has little theta right now. So stops on this are a close below the 50 day moving average, or a hard stop at 39, whichever comes first. All things being equal, that’s a total risk of ~$250. We make money provided we are above 45 by December, which is a reasonable thesis provided the market remains strong into the end of the year. If we see that thesis violated, we need to close out the position.

If we get a very fast runup, I’ll be looking for ways to hedge the position by buying puts, selling call spreads, or some other method to reduce exposure.

Execution/Risk Management:

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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