Bank of America, Puda Coal, and Tempur Pedic: Using Friday's Options Activity to Get Ready for Monday's Market

by: SA Editor Rocco Pendola

In addition to my own scans and watch lists, I use two main sources to follow options-related news: Daily Seeking Alpha columns by Frederic Ruffy and Andrew Wilkinson. While I get great use out of these sources and have even made money thanks to them, you have to be careful not to chase the stocks or options they mention. Often, by the time you receive an alert or summary, contracts have already had too much volatility and upside priced into the premium. Nevertheless, occasionally, you can find examples to capitalize on. Below I detail options brought to my attention by these sources and how investors might consider playing them - or the underlying security - if at all, during the trading week.

Bank of America (NYSE:BAC). Ruffy noted a bullish trade in shares of Bank of America, which closed Friday down nearly 1 percent at $13.48. A trader picked up 20,000 BAC April $14 calls. Ruffy speculates that this likely an optimistic play ahead of the company's earnings report due April 15th, which doubles as options expiration day.

With such a large block, the options buyer can profit it BAC seriously challenges the $14 level at the beginning of the new trading week. Unless I am absolutely certain about how a stock will react to earnings, I stay away from these situations. Not only do you have to guess the shape of the report, you need to know how the stock will react. Often, the street reacts negatively to one piece of slightly bad news in an otherwise sound filing.

I only like to play the volatile stocks ahead of earnings, using strangles and sometimes straddles. When using these methods, you generally only have to be right about one thing -- a wide swing in the stock. Direction does not matter because you are long both a call and a put. At times, you simply take your losses on end of the combination and your profits on the other. When it works correctly, your gains more than cancel out your losses. In some really volatile cases, you can make money on both ends.

Think of how stocks like (NASDAQ:PCLN) and Chipotle Mexican Grill (NYSE:CMG) have swung back and forth so wildly just after their recent earnings reports. An earnings report or two ago, I entered a strangle in (NASDAQ:AMZN) options a week before the report. I was able to exit each end of the trade -- for a profit in both cases -- before the company even announced earnings. Unfortunately, BAC does not fit the profile of a stock that will run hard enough in either direction pre- or post-earnings to make it a sound strangle or straddle play.

Puda Coal (NYSEMKT:PUDA). Puda Coal was one of Friday's biggest stories. The Chinese company that provides coal to industry in China tanked on allegations that its Chairman conducted improper share transactions. The company released a statement on Friday, noting that it is reviewing the charges.

Before PUDA tanked late in the day, Ruffy wrote about, at the time, out-of-the-money PUDA April $6 puts as the most active on the day. I can set my clock by Ruffy's posts, but the market moved too fast for him on Friday. From $6.48, PUDA plunged in the last half hour of trading to close at $6.00. That's a drop of $3.10 on the day, or 34 percent. PUDA traded between $5.77 and $8.84 on Friday.

A nimble trader could have been in and out of those puts within minutes for a nice profit. With the stock at $6.48, Ruffy reported the price of the PUDA April $6 puts as $0.48. They closed at $0.66. With the last bid listed at $0.65, your looking at a potential gain of $17 per contract if you got in at $0.48.

I would not chase PUDA in any direction out of the gate Monday morning. With Chinese fraud allegations, anything can happen. This stock makes for the ideal day trade if you can stomach the volatility that goes along with getting in and out of very short-term bounce plays. It's not for everybody, but with tight stops, discipline, a quick hand, and some luck, you can make money while managing potential losses.

Tempur Pedic International (NYSE:TPX). Having just purchased a mattress, I have some experience with Temper Pedic. While we decided to save a couple bucks and not go with a Tempur Pedic, we did splurge on their amazing pillows. They truly change the sleeping experience. And mine is so heavy, you could knock a burglar out with it.

Even though it's anecdote, I don't think I am alone in not being surprised by the company's announcement that it is raising guidance for 2011 and expects to report a strong first quarter on April 20th. With the economy and the consumer starting to bounce back in spots, it makes sense that some people have, presumably, stopped putting off the need to buy a new mattress.

If you put off buying TPX options, however, you might have made the correct choice. The shares skyrocketed on the news Friday, closing up more than 12 percent at $57.17. Wilkinson reports that interest in the TPX April $60 calls spiked with more than 2,200 calls traded, many at around $0.50. Unless options traders got out intraday for a profit, this example teaches them a lesson about chasing a stock that explodes using options.

TPX closed Thursday's trading day at $50.99. It opened Friday's session at $57.45. After trading as high as $59.98, the shares closed at $57.17, as noted. Those TPX April $60 calls traded between $0.10 and $1.20, closing up just $0.29 at $0.35. If you are stuck with calls you bought for $0.50, right now you're looking at a 50 percent loss, as the closing bid price stands at $0.25. You'll need a considerable bounce early next week to make money and a sustained run to have any chance of seeing your breakeven point of $60.50.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.