Research In Motion (RIMM) has been speaking about the launch of BB10 now for sometime. The release date has been changed multiple times but now the date has been set for January 30th. Analyst, bloggers, your neighbor, your dentist, etc…have all been enlightening you with their opinions about what the launch will do for the future of RIM. There are two consensus opinions. The first, that BB10 sales will far surpass expectations and will be the beginning of a turnaround for RIM. The second, that BB10 will fail miserably and RIM's share price is going to fall off the cliff (along with the rest of the economy). My response to both these opinions is……yes, I agree.
Before I explain why I agree with both opinions and share my investment thesis, I must explain one very important issue that every individual must comprehend before they enter the market. There are trades and there are investments. Trades are placed with expected profits to be made in the short run and investments are made with expected profits to be made in the long run. There are other differences between the two but that is for another day in another article. What is important to understand is that I am writing this article through the eyes of a trader (I have a long-term investment thesis for RIM which I plan on publishing in the near future).
As I stated earlier, I agree with both opinions. I view this as a binary event. Yes, BB10 can increase share price. Yes, BB10 can decrease share price. Bottom line is I believe it will not be at $11.76 (close price 12/27/2012) in the coming months. As a trader, I need to find a way to profit from my opinion which can be implemented in two ways, going short a butterfly spread or long a straddle. I recommend selling a butterfly spread but I will review each below. FYI, the key piece of data is that the launch is January 30th. This means that sales data will be released by the second week of February (before the Feb. options expiration dates). I will be demonstrating the trade using February options and for those who think the stock price will not reflect BB10 sales as of February I will also demonstrate using March options.
The way to implement a short butterfly spread is to short a call option at two differing strike prices and going long two call options at a strike price that lies between the two calls that you short. For example (you might want to get out a pen and paper to write this out); Short 10 RIMM Feb. calls with a strike price of 11 and short 10 RIMM Feb. calls with a strike price of 13. Buy 20 RIMM Feb. calls with a strike price of 12. This trade would provide you with a net credit of $90. This profit would be made if RIMM trades below $11.09 or above $12.91. The potential loss is $910 and occurs if RIMM trades at $12. Your potential return vs. capital at risk is 9.89%. If March options are used with the same strike prices the potential return vs. capital at risk is 7.53%.
Going long a straddle entails buying call options and put options at the same strike price and the same expiration. For example; go long 10 Feb. RIMM call options with a strike of 12 and go long 10 Feb. RIMM put options with a strike of 12. The result would be a net debit of $3,110 and this is also your potential loss (which would happen if RIMM trades at $12). Your breakeven points would be $15.11 on the upside and $8.89 on the downside.
The positive of going long a straddle is that you have unlimited upside and limit your capital at risk. The weakness of this strategy vs. the butterfly spread is the underlying stock has to have a far greater move to make the trade profitable. This is why I view the Straddle as having higher risk than the butterfly spread. For example; I stated above that your potential return vs. capital at risk for the butterfly spread is 9.89%. To make this same amount using the straddle the stock would have to go to $15.42 on the upside and $8.59 on the downside. This represents a 31.12% price increase for RIM or a price decline of 26.96%. Whereas for the butterfly spread the price of RIM needs to increase by 9.78% or decrease by 5.7%.
In short, I believe RIM will not be at its current level over the coming months and plan on implementing a short butterfly spread to profit from this view.
Disclaimer: All of the numbers used above are before cost. I did not implement cost into the example because it varies based on the trading site each individual uses. Before implementing these trades you must evaluate the trading cost and how much of your potential return will be decreased because of it. Many sites will charge so much for these trades that it simply doesn't make since to make them.