Using Friday's Options Activity To Get Ready For Monday's Market

 |  Includes: BAC, BBRY, LVLT, RAD, S, SIRI
by: SA Editor Rocco Pendola
In addition to my own scans and watch lists, I use three main sources to follow options-related news: Daily Seeking Alpha columns by Frederic Ruffy, Interactive Brokers and optionMONSTER.
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. 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.
My attention spans most of Friday's trading day, including early in the session, so some information may change. As with all of my articles, use my suggestions and analysis as the impetus for future research.

Research in Motion (RIMM). Just when you think it's impossible for RIM's co-CEOs to get it any less, they prove you wrong. The company acquired an Irish company, NewBay. Here's the lowdown on the deal from RBC Capital Markets analyst Mike Abramsky via Reuters:

... RIM will likely use NewBay's Internet-based photo and video albums, address books, calendars and other services as a base on which it will build up its content offerings.

"RIM is coming later to market than competitive offerings" from Apple's iCloud,'s Cloud Drive and services from Google , he said. "It's not known yet whether RIM's offering will match or lag the content and user experience of competitors."

I've said all I can say about RIM. The company's game of catch-up will not work. I'll let the latest RIMM white knight, Morningstar, insult your intelligence with a summary of RIM's ineptness that's a little too late. That said, it's on the money and refreshingly cogent via the Wall Street Journal.
At this point, ignore the various M&A-related dead cat bounces in RIMM. I have my eyes on $20 puts with expirations starting in January to play what should be underwhelming Q3 and Q4 earnings reports. I expect the teens, or lower, to become the norm for RIMM in 2012, if not sooner.
Sprint (NYSE:S). Here's Ruffy's midday Friday recap of the schizo action in S:

Sprint shares ran to morning highs of $3.39 after CNBC highlighted items from a conference call and noted that iPhone sales will result in huge cash flow for the company. However, the stock came under pressure and was halted after an AP story indicated that the company will stop selling Clearwire compatible products and Reuters reported that Sprint might need to access the market to raise capital. Shares hit a low of $2.65 when trading resumed and were recently down 17 cents to $2.84. Trading in options on the stock is brisk, with 68,000 calls and 18,000 puts traded on the name through midday. Players were sprinting for Jan 3.5 calls in early trading and the flow included a morning buyer of 3,739 contracts at 50 cents on ISE. 9,100 traded and the market is now 35 to 38 cents. Oct 3.5, Oct 3, Jan 3, Weekly 3, Nov 3.5. and Nov 4 calls on Sprint are seeing interest as well. Meanwhile, implied volatility in the options is ripping 15.5% higher and is elevated at 112.5.

I wrote an article this week - RIM, Sirius, BofA and Level 3: Catching Falling Knives - and one earlier in the week warning of the potential pitfalls of investing in sub-$5 stocks. I spoke, in both of those articles, from experience.
I had some S calls not too long ago that expired worthless. I also took a small loss on Bank of America (NYSE:BAC) several weeks back. In both cases, I looked at the share price. I then looked at the enormity of each company and something told me that the stocks could not go much lower. Not sure what, other than psychological mind games (e.g., tell yourself it's a good buy because if the stock rises considerably, buying in at such low levels will generate significant profits with very little risk).
My analysis of RIM should have kept me out of both S and BAC. RIM's woes tell us several things:
  • It doesn't matter how big a company is; the share price can always go lower.
  • Just as a "high" P/E does not automatically equal overvalued, a low P/E often does not signal undervalued.
  • If management appears unclear in relation to strategy (e.g., Sprint) or, worse yet, seems not to have a viable plan, stay away.

I've read lots of StockTalks, Tweets and such over the last several days where investors have noted that the time looks ripe to get into Sprint. I'm not falling for it this time. And, frankly, I'm proud of myself. As I continue to work at this racket, my emotions - at least the potentially damaging ones - enter my trading/investing decisions less and less.

Consider Rite-Aid (NYSE:RAD). Even while I was bearish, I must admit to almost being swayed by the bulls as the stock looked like it was set to sustain over $1.00 per share. Of course, with a keen eye and some nimble timing, you could have made a decent buck on RAD between 2010 and just a few days, weeks or months ago.

During one of my introspective moments, I seriously considered pulling the trigger - and with some size - on the lotto ticket of all lotto tickets -- ultra-risky RAD calls. I could have gradually loaded the boat, stroking my ego along the way. Hey, see that open interest, sweetheart, that's all me! Boo-yah!! Thankfully, I did not. RAD has more baggage than Sarah Palin. The stock, yet again, trades under a buck.

Of course, not all sub-$5 plays end so poorly. Just as you could have made money with RAD over the last year, you could have made money with a stock like Sirius XM (NASDAQ:SIRI). I profited by trading it throughout 2010, particularly around the time Howard Stern signed for another five years. The key is recognizing when the run is over.

Emotion keeps traders and investors in stocks like RAD in the $1.30s and $1.40s and SIRI at above $2.00. Your mind tells you that the ride won't end just yet, it can't. Nobody wants to take the dream away from themselves. It's human nature. So you follow the calls to "buy more." You get caught up in the psychological tsunami that promotes irrational behavior in response to falling stock prices.

It's funny how investor psychology works. One investor will google S, BAC, RAD, SIRI or similar stocks and find the many message boards that allow anybody with a keyboard to "comment" on the stock. That investor will make what is probably the prudent choice - run away after lamenting society's LCD. Another perfectly sane individual will get sucked into the trap, let emotions and the dream take over and make what is probably too big and too risky of a buy. It's an interesting dichotomy that you can probably apply to many other areas of life.

Level 3 Communications (NASDAQ:LVLT). Speaking of dream-toting sub-$5 traps, optionMONSTER highlighted a worthwhile options trade on LVLT:

Shares of Level 3 Communications have seen large price swings this week, but one trader is looking for it to calm down.

optionMONSTER's monitoring system detected the sale of 6,600 November 1.50 calls for $0.25 to $0.30 and an equal number of November 1.50 puts for $0.05 to $0.10. Volume was more than twice open interest in both strikes.

LVLT is up 2.8% to $1.66 in afternoon trading. The broadband communication company spiked as high as $2.40 on Wednesday, followed by another push to $1.85 yesterday. Both times the shares quickly met with selling and fell back toward their recent range.

All that movement has pushed up implied volatility to about 85% from about 75%, which has also boosted premiums. Traders often sell calls and puts when they think that options are pricing in too big a move.

Known as a short straddle, the position is an example of a market-neutral strategy that makes money from the passage of time rather than a direction move.

While I would not recommend this aggressive and risky of a strategy for everybody, it's one that I believe has merit. If you can learn the ins and outs of selling volatility (and I include myself in that "you"), you can go a long way to making a living trading or, better yet, generating much-needed income in almost any portfolio.

Disclosure: I am short RIMM.

Additional disclosure: I may add to my short position in RIMM using January and/or March and/or June $20 put options early next week. I may also open short positions, using options, in BAC, SIRI or LVLT over the next 72 hours.