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Ryan Snefsky currently serves as President and Chief Executive Officer of Capital Ingenuity Corporation. He has 15 years of investment experience with equities, equity options, and funds with varying types of legal structures. Prior to founding Capital Ingenuity in 2005, he served as a... More
My book:
Ten Options Myths: Don't Let These Common Misconceptions Hinder Your Success
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  • Some Stock Analysts Make Monster Missteps

    About a month ago, Morgan Stanley and UBS downgraded Monster Beverage (NASDAQ:MNST) stock, sending its shares on a tailspin. But, last night, Coca-Cola (NYSE:KO) announced a 16.7% stake in Monster at a cost of $2.15B in cash. Announcement of the purchase sent Monster shares through the roof, up about 28% in extended hours trading. In short, the analysts making these downgrades totally blew it, and Coke new it. So, what's the take-a-way here?

    Many amateur investors place a tremendous amount of trust on analyst ratings, blindly following recommendations on the headline of an upgrade or downgrade from a company that the investor "perceives" as being an authoritative source. But, don't be fooled. Analysts at seemingly respectable companies get it wrong all the time for a variety of reasons, each of which could take its own full blog post to explain.

    Do I pay attention to analyst ratings and research reports in my own investing endeavors? Sure. I take note of them. But, I don't act on them. I take note of the overall trend of ratings for a given stock. I'm more interested in a rating given by an analyst with a strong track record, compared to those who are average. I take note of the overall field of analysts covering a stock to see if the ratings are strongly weighted in one direction or another. If all the analysts covering a stock already rate the thing a "strong buy", is there really much more room on the upside?

    More so than the ratings themselves, I am interested in the research reports that hopefully come with the ratings. But, even these I take with a monster grain of salt. I use these largely as a way to double check that I didn't miss anything in my own research. And, even if I see a new thought in a research report, I always ask myself if I agree. I read this stuff with an extremely critical mind, rather than taking the words as truth.

    I never lose track of the fact that, often, there is a highly paid, highly educated analyst telling me to buy something, while somewhere out there, one of his/her former classmates is telling me to sell. I'll hear both of them out and see where I agree and where I do not. Their words, after all, are referred to as "analyst opinions", not "analyst truths".

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: This post was originally published on the author's personal blog.

    Tags: MNST, KO
    Aug 15 5:52 PM | Link | Comment!
  • SPY: How To Reduce The Risk And Capture The Upside

    With the SPDR S&P 500 ETF (NYSEARCA:SPY) trading at $152.11, we are getting tremendously close to a level of resistance that has plagued this ETF for years. On October 11, 2007, SPY hit its all-time intraday high of $157.52 before tumbling down into the depths of the great recession. On March 24, 2000, at the peak of the dot com boom, SPY reached a record intraday high of $155.75 just before the dot com bust.

    As we approach these lofty price levels yet again, many investors are beginning to get nervous about downside pressure and the possibility of SPY forming one of the biggest triple tops of all time. Fortunately, investors wishing to be long SPY with a longer time horizon can use a great risk-reducing options strategy: the risk reversal.

    A risk reversal involves buying a call, preferably at-the-money or just out-of-the-money in this particular case, and selling an out-of-the-money put to finance the cost of purchasing the call. The idea is to try to structure a position where there is a net credit to your account after both positions have been entered.

    Using a risk reversal right now may seem a bit counter intuitive, as it's typically used after a stock has recently fallen. However, by looking at expirations that are further out in the future, you may find that the value of SPY puts substantially exceeds the value of the calls. This sets up for a great risk reversal. Let's look at some real numbers.

    For this example, let's look at the January 14, 2015 option chain. A slightly out-of-the-money 155 call currently has an ask price of $10.63. As this the purchase of this option ties up $1,063 and has a breakeven point that is about 8.9% above the current price for SPY shares, let's look at selling an out-of-the-money put that will bring in more cash than the cost of the long call.

    The bid on the 139 put is currently $11.08, so selling one of these would bring in $1,108. When we take this credit from the sale of the put and subtract the debit of $1,063 for the cost of the call, we find that this transaction has a net credit of $45, excluding the cost of commissions. While this credit alone is not particularly attractive, let's take a look at what's actually happening here.

    If SPY goes up shortly after entering this specific risk reversal, the long 155 call will likely increase in value. Simultaneously, the short 139 put will likely decrease in value, which further increases the overall profit on the position. This risk reversal effectively allows us to be long 100 shares of the stock at $155, but without having to part with $15,500. As a matter fact, you'd actually be getting paid $45 to effectively be long 100 shares.

    Let's look at the other side of the coin. After all, the reason we're looking at the risk reversal in the first place is because we might be concerned that the share price could be running into some significant resistance. If we short the 139 put and the price drops below $139 per share, then we're obligated to buy 100 shares of SPY at $139 per share if we are exercised.

    While the risk reversal effectively creates a long position with all the upside potential above $155 per share, it's not actually a long position. We don't have a true long position until SPY drops below $139 per share and we experience exercise. If the price drops below $139 per share, but exercise never occurs, then we still don't have a long position.

    The great part about the stock falling is that if we were originally willing to buy 100 shares at the current market price of $152.11, and we get exercised while the shares are below $139 per share, then we end up paying a price for our shares that is 8.6% lower than the current market price today. So, we get all the upside above $155 per share, but we don't even have to actually buy the shares unless we are exercised at a price that is at a significant discount to the current price.

    Now, suppose SPY's share price drops, but not below $139, prior to expiration. In this case, it's quite possible that we'll see a paper loss on the position. However, if the price stays above $139 per share until expiration, the time value will progressively bleed off of our short put, which will offset the loss experienced by the drop in value of our long call. In this case, upon expiration, we would ultimately see a profit of $45 even though the shares declined in value from when we entered the position.

    Think about that for a second. We have unlimited upside potential above $155, yet we still show a profit of $45 if our short put is not exercised at a price that is 8.6% below the current market price. For an investor who is willing to have an SPY position of at least 100 shares as part of a core long-term position, this is an amazing risk/reward profile compared to simply owning 100 shares outright.

    The specific strikes and expirations used in this example do not need to be used to execute this strategy. As a matter fact, upon looking at the January 2015 option chain, you may wonder why I didn't choose a put with a higher strike price for our short. By using a higher strike price, we could create an even better credit than $45. However, by creating a bigger credit, we also can create a less favorable breakeven point if the stock moves against us. With the strike prices I used in this example, the breakeven price is $138.55, or $139 per share minus the $0.45 per share credit.

    Rather than have a bigger credit upfront that is probably marginally insignificant over the scope of about two years, I prefer to have a lower breakeven point that provides me a better discount on the shares if I am forced to buy them. January 14, 2015 is a long way off from today and a lot can happen between now and then.

    Disadvantages

    While I love the risk reward profile of this risk reversal compared to owning 100 shares of SPY at current prices, this strategy is not without some critical disadvantages. Let's take a look at a few.

    This strategy can only be used by investors that are willing and able to buy 100 shares of SPY at $139 per share. The short leg of this strategy involves selling a put. If the short put is exercised, you must have enough cash or margin available to purchase 100 shares for each put that was sold short. If you can only afford to buy 25 shares of SPY or you can't buy a full 100 shares without being adequately diversified, then you may instead want to consider outright ownership of the shares.

    This strategy may not be permitted inside of qualified retirement accounts with many brokers. Risk reversals require you to be able to both buy calls and short puts. Check with your broker to learn what types of options transactions can be done inside of a qualified retirement account.

    If SPY only rises slightly by expiration, it's possible that you would have made more money by just buying shares outright. Suppose the price at expiration only rises to $153.00. If you had purchased 100 shares of SPY at the current price of $152.11, you would have a profit of $89.00 from capital appreciation. Additionally, you would also have collected almost two years worth of any dividends SPY distributes. Had you have entered this specific risk reversal, your profit would only be $45. This, of course, leads us to another disadvantage.

    The risk reversal does not allow you to receive SPY dividends. SPY's current dividend yield is 2.07%. While this is not huge, it is a source of income to your portfolio and also provides a level of protection against a decline in the value of the shares. That being said, the protection it provides is not currently as substantial as the risk reversal on a percentage basis.

    Conclusion

    Despite the disadvantages to this strategy, I like the risk/reward profile for this risk reversal compared to that of owning 100 shares of SPY for the long-term. I would certainly be willing to sacrifice a 2% dividend yield to have 8.6% of downside protection if I hold until expiration. As SPY approaches a major resistance point, it's certainly prudent to assess the risk of owning the shares. But, if the shares can break through the resistance, I want the ability to capture all of the upside. I think that a risk reversal like this one is a great tactical move for the investor looking to own at least 100 shares of SPY in the current market environment.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Feb 19 1:45 PM | Link | Comment!
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  • We're above 2007 inflation adj highs, but below 2000 inflation adj highs. This is exactly why investors are skittish at these levels. $SPY
    Aug 18, 2014
  • $SPY is now trading 10.5% > its Oct 2007 (inflation adj.) high. But, it would have to rise 10.4% to reach Mar 2000 (inflation adj.) high...
    Aug 18, 2014
  • Some Stock Analysts Make Monster Missteps $MNST, $KO http://seekingalpha.com/p/1vyut
    Aug 15, 2014
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