Seeking Alpha
Long/short equity, value, growth at reasonable price
Profile| Send Message|
( followers)  

Hopefully by reading my previous article you've become a bit more bullish on Ford (NYSE:F). In Part I, I wanted to convey why I have been bullish the past several months when Ford has increased over 20%. In Part II, I am looking to explain long options positions for this particular trade. To recap, we've got a few things working in our favor as shareholders:

  • Very strong technicals working in a bullish manner
  • Three consecutive earnings beats
  • Alan Mulally will remain the CEO until at least 2014
  • Ford has begun to contain European losses
  • Very strong growth in China
  • Strong domestic sales, with 5 models being in the top-20, including the number 1 selling vehicle
  • Strong presence forming in the hybrid car sector, including the top ranked hybrid for 2012

The Trade

With so many options (no pun intended) in the financial world today, what's the best way to play a rising move in equities? Everyone has a different method, and some work better than others. Some prefer credit spreads, some prefer debit spreads, or some might just buy outright shares. While there's not really a wrong way to play, some can be more advantageous than others.

In this particular case I don't like owning the shares outright. Essentially, the main reasons to own shares are for dividend payouts and voting rights. Ford has a pretty small dividend, a $.05 quarterly payout, which isn't really enough to get me on board with owning the stock. The voting rights don't really matter to me either. Therefore, I am going to stick with using options for this bullish play on Ford.

That leaves us with the choice of which options strategy to use. Should we sell puts? What about purchasing bull call spreads? Personally, in this specific case I don't like either one of these options. We don't collect enough premium from selling the put spread, nor is the risk-to-reward very balanced when it comes to selling the top calls in a bull call spread. Therefore, I honestly think the best way to play this impending move is also the simplest, by purchasing outright calls on Ford.

Now that we've got the strategy down, which strikes and expirations should we choose? It depends on your goals and investing objectives, but there a few different choices here. The first, if you are looking to replicate owning the stock via options, you could purchase deep-in-the-money call options on a long dated contract, such as the January 2014 5.00 or 8.00 strike calls. It would look like this:

BUY 1 January 2014 5.00 Call @ 7.70

Delta: 100

With a delta of 100 and essentially being comprised entirely of intrinsic value (meaning no time value because it is so deep-in-the-money), the option will move literally step for step as the stock does. If Ford is up $.15, you can count on the options to be up $.15 that day too.

For those who are looking for this trade to pan out, but aren't looking to replicate the stock, there are options for you as well. Currently you could buy the 11 strike or 12 strike to take advantage of more upside movement. Personally, if I had to choose right now, I would be a buyer of the 12s, assuming this bullish run continues. Here are the trades below and we'll talk about their differences:

BUY 1 March 11 Call @ 1.68

Delta: 80

Gamma: 14

Days Until Expiration: 50

BUY 1 March 12 Call @ .99

Delta: 62

Gamma: 20.5

Days Until Expiration: 50

Aside from the initial debit, there are other several differences. With a delta of 80, the March 11s will track the movement of Ford more closely than that of the March 12s. This is a good thing if the stock is going up, but bad if it's going down.

Gamma measures the speed in which delta will move, either increasing or decreasing. Gamma is good when you buy something like the March 12s, as the increasing stock price will drive the option premium up much quicker due to the faster delta acceleration, which is the gamma. This effect is two-fold however, and will determine the speed of how fast the delta will decrease should Ford start to decline in the coming days and weeks.

Gamma can be defined as delta's acceleration, to clarify the above statement.

To take advantage of a situation like this, allow me to demonstrate what I did when I was playing the impending move for Ford's stock price to continually increase from $10.50 in November:

Buy-To-Open March 10 Calls @ 1.05

Sell-To-Close March 10 Calls @ 1.60

Buy-To-Open March 11 Calls @ .90

Sell-To-Close March 11 Calls @ 1.55

Buy-To-Open February 12 Calls @ .98, Sell-To-Open February 13 Calls @ .44

Please note that I'm not doing this in a self-absorbed manner, but am openly displaying my recent trades for the purpose of helping others who are new and/or struggling with options. I rolled out of the 10s in favor of the 11s (and out of the 11s in favor of the 12s) for several reasons, which I'll state below:

  1. If another big move to the upside occurred for Ford, I would achieve a higher percentage return on the 11s, rather than the 10s.
  2. To limit delta risk. When Ford moved from the $10.50 range to the 11.50 range, the delta moved from approximately 60 to around 85. If Ford pulled back significantly, due to macro or stock specific reasons, the price of the options would also decline significantly. The 11 strike calls, however, would decline less than the 10 strike calls, due to the lower delta measurement, since it would track Ford's stock price less closely than the 10s would.
  3. I wanted to book profits and by selling-to-close the 10s I could lock in what was then unrealized profits. By purchasing the 11s for around the same debit as I did the 10s, I could realize my gains on the previous trade while simultaneously participating in more upside movement. This not only limits my risk to the original net debit (or close to it), but limits my risk further by realizing gains.

Didn't I just say I didn't like the risk/reward ratio of using bull call spreads in this scenario? Some might be wondering why I sold the February 13 calls against my long February 12 position if I expect the stock to continue this advance. After all, I didn't sell covered calls before, so why now? I'm doing so now because I missed the "sweet spot" I was looking for when buying the next strike price up. Instead of waiting for the stock to fall before buying more calls, I decided to buy now since Ford has traded with such strong price action.

Even though it is considered overbought, I didn't want to miss out on more upside gain, but wanted to be protected in the event that Ford corrects -- and hopefully it does. Should Ford fall, perhaps to its 20-day or 50-day simple moving average, I will look to buy back the short February 13 calls for a slight gain, thus leaving me only with the long February 12 calls. This is the plan and I do prefer owning the outright calls most of the time. However, I felt as if it was most advantageous to spread the position in the event of a pending correction.

To be clear, I am not using a bull call spread as my permanent strategy, only a temporary one to protect against a pullback, while still being long.

Like I stated before, I don't think there's really a wrong way to play this. You could easily buy the 11s or the 12s if you plan on holding to or near expiration. But if you plan on adjusting them like I have in the above examples, you should be a little pickier with the strikes you select and at what price you pay.

I think Ford has a great fundamental outlook. It is doing all the right things and is finding ways to mitigate the effects from the European region. By enhancing Chinese and domestic sales with high quality products, Ford will continue to build its brand awareness and customer loyalty. From a technical standpoint, the charts look beautiful and remain very strong for the intermediate future, especially with such heavy volume. I will remain long and bullish until one of these factors change and I am forced to reevaluate the situation.

Note: In the near future, Ford will be issuing more shares of stock. This could create short-term downward pressure on the stock and be the acting catalyst for the pullback we were talking about, although it is less than 5% of outstanding shares. For more insight on the pending issuance, please read this article by Seeking Alpha contributor Adam Levine-Weinberg.

Source: Ford: Ready For More Gains? Part II