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In previous articles we discussed a potential married put trade following the RadioActive Trading techniques on a stock that had an upcoming earnings event. We also compared that trade to what is called an in-the-money long strangle position, substituting stock ownership with a long call combined with a long put. We compared these two options positions with example trades on eBay Inc. (NASDAQ:EBAY) after earnings and selected GNC Holdings Inc. (NYSE:GNC) for our second comparison. Our expectation was that the stock would have a positive earnings report and the stock would rise in price. GNC did have positive earnings...but the stock did not rise in price.

Well, these things happen, and this is one of the main reasons we prefer to trade protected stock positions instead of relying on basic stop orders. Earnings were positive: The estimate for GNC's Q3 earnings on 11/1/2012 was $0.58 per share, and the company reported earnings of $0.61 per share. Guidance was raised, revenues grew by about 15% and all news was positive.

And...shares of GNC Holdings Inc. plummeted after the announcement. GNC Holdings shares fell by as much as 13% after the earnings announcement, then recovered by market close on November 1st. Why did this happen after earnings were positive once again and the stock showed continued growth? There is speculation over recent events surrounding the Monster Beverage Line (NASDAQ:MNST), maybe the market was not satisfied with forward looking guidance or maybe the stars had aligned in such a way that GNC was going to gap down 13% regardless of the reported numbers.

What is important to us as share holders is where we stand now and what is our forward projection for the underlying stock. Had we placed this trade using a stop order rather than a married put we would have had our shares taken away from us for a loss. By properly insuring the trade with a married put position we were able to ride out the initial over-reaction, realizing that we were never at risk for more than 6.7% of our invested capital even if the stock had a more drastic decline.

GNC Married Put position:

Here was the initial setup of the GNC married put position on October 24th, 2012:

Buy shares of GNC Holdings @ $37.98 ($3,798.00 per 100 shares)

Buy 2012 NOV 11 strike put @ $ 4.90 ($490.00 per 1 contract)

Total dollar amount invested = $42.88 ($4,288.00 per 100 shares)

Guaranteed by put option = -$40.00 ($4,000.00 per 100 shares)

Maximum risk on position = $ 2.88, or 6.7% ($288.00 per 100 shares)

Maximum profit on position = Infinite

RPM after initial announcement:

GNC Holdings Inc. closed at $38.67 on October 31st. The stock was up 1.8% from our initial purchase price. The earnings announcement did not disappoint us as stock holders, but the market reaction to the earnings report was disconcerting. Since we had the put in place to protect our shares, we were not forced out of the position as we would have been with a stop-order in place. This gives us the ability to wait out the initial over-reaction without losing our shares of stock. Even though GNC Holdings Inc. plummeted after the initial announcement, the stock had recovered slightly by market close on November 1st:

GNC Holdings Inc potential liquidation on November 1st:

Sell shares of GNC Holdings @ $37.53 ($3,753.00 per 100 shares)

Sell 2012 NOV 11 strike put @ $ 5.00 ($500.00 per 1 contract)

Liquidation value = $42.53 ($4,253.00 per 100 shares)

Liquidation loss = $42.53 (liquidation value)- $42.88 (original cost basis) = -$ 0.35, or -0.8%

We could have exited the married put position for only a small loss, much less than the initial maximum risk of 6.7% when the position was opened. Remember, because we purchased the in-the-money put far out in time, the protective put does not decline 1:1 with the stock. As we are still long term bullish on GNC, we stayed in the position rather than take the small loss.

Where do we stand today? On Friday, November 2nd and Monday, November 5th GNC Holdings Inc. continued to decline. As of close on Monday, November 5th the married put stood as:

Sell shares of GNC Holdings @ $35.72 ($3,572.00 per 100 shares)

Sell 2012 NOV 11 strike put @ $ 6.10 ($610.00 per 1 contract)

Liquidation value = $41.82 ($4,182.00 per 100 shares)

Liquidation Loss = $41.82 (liquidation value)- $42.88 (original cost basis) = -$ 1.06, or -2.5%

By staying in the position our unrealized loss did increase as GNC continued to decline, but we are still well below our maximum risk level for the position. We still feel GNC will recover and we may look to adjust the March 40 strike put option to generate income and lower the cost basis of the protected position.

Comparison - GNC Holdings Inc. Long Strangle:

Unlike our previous example of the eBay Inc married put vs. long strangle in this example the in-the-money long strangle had a small loss. If the position was closed immediately following the earnings report a gain could have been realized. Here was the initial long strangle as of October 24th, 2012:

Buy 1 March 35 call @$ 5.20

Buy I March 40 put @ $ 4.90

Total Invested = $10.10

Maximum Risk = $ 5.10, or 50.5%

Maximum Profit = Infinite

After the initial market reaction and the slight recovery, the closing prices for the in-the-money long strangle on November 1st were:

Sell 1 March 35 call @ $ 5.00

Sell 1 March 40 put @ $ 5.00

Liquidation Value = $10.00

Liquidation Loss = $10.00 (liquidation value) - $10.10 (original cost basis) = -$ 0.10, or -0.9%.

This shows once again the potential dangers of leverage. We would have loss less monetarily on the long strangle compared to the married put, provided that we only traded 1 contract for each leg of the strangle. But, if we had invested the same amount of capital into both positions, we would have purchased 4 contracts of each leg in the strangle position resulting in a loss of -$0.40 (higher than the married put position), or 3.9% of our invested capital. At the time the married put was only down 0.8% of the $4,288.00 invested.

At close of business on Monday, November 5th the values for the long strangle were different, but the outcome was essentially the same. With GNC Holdings Inc. closing at $35.72 the March 35 call had a bid of $3.90 and the March 40 put had a bid of $6.10. The liquidation value would have still been $10.00, resulting in a liquidation loss of -$0.10, or -0.9%, which is less of an unrealized loss compared to the married put position.

Unlike the eBay, Inc. comparison neither position on GNC Holdings Inc. is currently profitable. Even though the loss on the in-the-money long strangle is less than the married put position as of close of Monday, November 5th, it is always important to emphasize the dangers of leverage and proper money management. By having the put in place instead of a stop-order we were in control, and did not have our shares taken away from us for a significant loss after the market reaction to the earnings event. We are still long GNC Holdings Inc. with the protective put in place and may adjust the put to lower the cost basis of the position if an opportunity presents itself this week.

Source: GNC Holdings Inc. Follow Up: Positive Earnings But Market Disappointment