This strategy not only provides you with the opportunity to leverage your position in EMC Corporation (EMC) but it also provides one with the chance to get into the stock at a much lower price. Only put this strategy to use if you are bullish on the stock as there is a chance that the shares could be put to your account. If you are not bullish on the stock, then it would be in your best interest to look for alternative plays.
Technical outlook for EMC Corporation
The stock has a pretty decent amount of support in the 24.50-25.00 ranges. It has broken through this zone several times, but has always managed to trade above it in a relatively short period of time. It is trading above the +1 standard deviation Bollinger band, and in the past few months when this has occurred, it has tended to pull back and temporarily dip below support at 25.00. There is a much stronger layer of support in the 23.50-24.00 ranges. As it appears that the stock is getting ready to pull back again we would wait for at least a test of 24.00 before putting this strategy into play.
Note that the bands are getting tighter again, which suggests that it is getting ready to break out soon. For example, this occurred from Sept 2011- Oct 2011 and then from Dec 2011- Jan 2012. On each occasion, the tightening of the Bollinger bands provided advance warning that the stock was getting ready to break out. The next downward move could lead to a rally that pushes it to test the 29-30 ranges.
Suggested strategy for EMC Corporation
This play has two parts to it. The first part entails selling a put and in the second part calls are purchased with the proceeds from part 1.
The Jan 2013, 24 puts are trading in the $1.00-$1.03 ranges. If the stock pulls back to the suggested ranges the puts should trade in the $1.65-$1.80 ranges. For this example, we will assume that the puts can be sold at $1.65. For each contract sold $165 will be deposited into your account.
The Jan 2013, 29 calls are trading in the $0.85-$0.88 ranges. If the stock pulls back to the suggested ranges, the option should drop to the 0.45-$0.55 ranges. We will assume that each call can be purchased for $0.55 or better. The sale of each put will enable you to purchase up to 3 calls. Those seeking even more leverage, could aim for the Jan 2013, 30 or 31 calls. You do take on more risk the further out of the money you go.
Benefits of this strategy
- The opportunity to leverage your position in this stock for a relatively low cost. You would only need to put up $2400 for each put you sold. In return, you would be in a position to control up to 300 shares. If you purchased those shares today, you would have to pay roughly $7900.
- You also have the opportunity of getting into the stock at a lower price. If the stock trades below the strike price you sold the puts at, the shares could be assigned to your account (assignment usually occurs on the last trading day of the option). Depending on the number of calls you purchased your cost per share could range from $22.90 (if you purchased one call only) to $24.00 (if you purchased three calls).
The only real risk is that you have a change of heart and feel that the stock could trade well below the strike price you sold the puts at. In this case, you could roll the put. Buy back the old puts and sell new out of the money puts.
While the trend is still up the markets are in a volatile phase. Consider closing half the position out if the calls are showing gains in the 60%-100% ranges. Place a 50% profit stop after you close out half your position.
Options tables sourced from yahoofinance.com. Option Profit loss graph sourced from poweropt.com.
It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article was prepared for Tactical Investor by one of our analysts. We have not received any compensation for expressing the recommendations in this article. We have no business relationships with any of the companies mentioned in this article.