2 Options Strategies To Profit From Dow Chemical

Jan.20.12 | About: Dow Chemical (DOW)

Thursday afternoon (Jan. 19, 2012), CNBC's Pete Najarian reported that he'd seen a sizable uptick on call options on Dow Chemical (NYSE:DOW). Specifically there was unusual volume in the Feb. 35 calls when the stock was around $33.00. With Dow earnings scheduled for release on Feb. 2, one or more big-money investors are expecting a pop prior to the Feb. 18 expiration date.

I'm personally not a fan of naked OOM calls - even when they're selling for only $0.43 like the DOW Feb. 35 calls. So here are two other option strategies that better suit my risk-reward parameters - and perhaps yours as well.

The more conservative approach would be to employ a buy-write strategy, and the table below illustrates several potential buy-write trades with February, March, and June expirations.

Here's how to read the table: Dow closed at $32.98 on Thursday. You could have sold a Feb 35 call for $0.43. If Dow were at or above the strike price of $35.00 at expiration, the stock would be called away and you would enjoy a return of 7.4% (the $0.43 option premium plus the cap gain of $2.02). If Dow stays below the strike price, you could sell another call and receive another premium. (Note: If you were to write June options, you'd also collect a $0.25 dividend that would further increase your return, but is not included in the numbers provided below.)

An alternative approach to profit from Dow's potential upside is a vertical spread. It's certainly a riskier play, but also offers considerably more upside. The following table illustrates two bull spreads expiring in both March and June.

Here's how to read this table: With DOW at Thursday's close of $32.98, you could have bought a March 31 call for $2.95 and sold a March 35 for $0.80. The cost of the trade and your maximum loss would be $2.15. Your maximum return would equal 86.0% (the proceeds of $4.00 minus the cost of $2.15). Dow would need to be at $33.15 at expiration for you to break even on the trade (the long strike of $31 plus the $2.15 cost of the trade). Each of the four scenarios is structured so that the break-even price point is reasonable, thereby reducing the chance of loss in the trade.

Click to enlarge

Please keep in mind that all these numbers would be reduced by transaction costs.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DOW over the next 72 hours.