Using Friday's Options Activity To Get Ready For Monday's Market (Part One)

Includes: MCD, NFLX, S, STMP
by: 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. (NASDAQ:STMP). While I have never paid much attention to STMP, I do pay attention to options trades that I missed that triggered massive gains. Interactive Brokers highlighted some seriously profitable call activity in STMP options in its Friday column:

The Nov. $20 strike call was one area populated by bullish players. Open interest in the call stands at 1,145, and it looks like more of those positions were initiated by buyers than sellers for an average premium of $2.50 each. These calls are now nearly five times as expensive, with the last-traded price on the option displaying $12.10 as of 12:25 pm EDT. Investors enjoying a much quicker turn-around on their position snapped up around 220 calls at the Nov. $25 strike for an average premium of $1.69 apiece earlier this week. Traders buying the Nov. $25 strike call today paid an average premium of $4.93 a-pop, or roughly three times as much post-earnings.

Let's break that down into actual costs bases and profits. Even small investors could have turned a meaningful profit - in dollars - by getting behind STMP ahead of earnings.

Using IB's figures, one STMP November $20 call would have run you $250 prior to earnings. If you flipped just one contract intraday Friday for $12.10 ($1,210) that's a profit of $960, excluding commissions. Put another way, a $1,000 investment in five STMP November $20 calls at $2.50 each would have yielded almost $5,000 in profits on a post-earnings exit.

And, according to IB, some traders continue to storm into STMP November calls with $30 and $35 strike prices. While you run the risk of missing out on further strength, I would prefer to (A) take profits if I had the foresight to make this trade in the first place or (B) lay off on betting on further upside.

There's nothing wrong with taking profits. While I might have my regrets for missing out on the Netflix (NASDAQ:NFLX) implosion, I have no regrets on another recent trade that I touched on last week. I profited on McDonald's (NYSE:MCD) run past $80 using calls, but did not stick with the stock through $90. Bottom line - for every dollar you leave on the table doing that, you probably saved yourself five by not getting too greedy on a play that loses its momentum.

Sprint (NYSE:S). Many Seeking Alpha members who read this column regularly email me noting that they're just getting started with options. If that's the case, there's no better way to get a feel for how options function than by writing covered calls. In this regard, starting out on the short side of a trade - as a seller - helps provide you with the knowledge you'll need to be a successful buyer of calls and puts.

The covered call trade I have on against my 900-share long position in S appears to be going off in textbook fashion.

Click to enlarge

The call shows an unrealized gain of $114.99, as the premium rapidly loses value thanks largely to time decay. And, of course, I called at least a near-term bottom in shares of Sprint, snagging them for $2.17, after commission. I don't expect S to move more than 10% between now and the November options expiration day to bring it to a point where it would be likely that I'll get my shares called away. And, even if I do, it will have turned out to be a profitable trade with little stress over a relatively short period of time.

Go to Part Two of this week's options article to review the performance, as of Friday's close, of the $10,000 portfolio. I also provide thoughts on the status of each trade.

Disclosure: I am long S.