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A Risky Bet On GE With Options

|About: General Electric Company (GE)

Last Thursday GE got hammered by the Markopolos fraud allegation.

The market reaction was way overblown.

This seemed like a golden opportunity to place an option bet on this dark horse.

On Thursday morning (Aug. 15), Harry Markopolos released a scathing report alleging that GE engaged in accounting fraud with respect to its long-term care business and that GE is “a bigger fraud than Enron.” GE’s stock price fell precipitously, tumbling more than 10% from its 9.03 closing price on Wednesday to a low of 7.65, spending a good part of the day in the 7.90 region and eventually closing at 8.01. Obviously, this was panic selling by large numbers of so-called professionals, who certainly did not have time to thoroughly investigate or even get a response from GE.

I decided this might be an opportunity to take a gamble on GE. While I had no other information one way or the other, I just had an inkling that this whole thing was way overblown. It struck me as highly doubtful that GE was “a bigger fraud than Enron.” Let me assure you, my inkling was no more founded in reality than someone saying “I gotta feeling about that horse.”

Not A Traditional Gambler

I am not a gambler in the traditional sense. I don’t buy lottery tickets and I don’t play the slots or the ponies or poker. I’ve literally walked through a casino without placing a single bet. The closest I’ve come to gambling was to buy a box in the office Superbowl pool back in the days when I was working. And that was for fun and collegiality more than a hope to win anything.

That being said, I have occasionally gambled in the stock market. The recent Markopolos GE stock manipulation tickled my gambling fancy.

An Opportunistic GE Option Trade

I decided to look at options as a way to place my bet that GE might recover from what appeared to be an overblown selloff. Sometime during the middle of the trading day on Aug. 15, with GE sitting just below $8, I bought $9 calls expiring in Dec. (cost $0.56), and sold $6 puts expiring in Dec. (credit $0.36), for a net cost of $0.20. This was a risky move because if GE continued to go south, the call premium would diminish over time and eventually go to zero, the put premium would increase as the stock price declined and, ultimately, I could be assigned shares of GE at the $6 strike price if GE’s price closed lower than $6 on the Dec. option expiration date.

With options you need to be right on two parameters. First, you need to correctly guess which direction the stock price will move. And second, you need to correctly guess the time frame in which such movement will occur. While many option traders play with close expirations (weekly or monthly), I have no confidence in my ability to get the time frame correct. So I tend to play with options that expire at least a few months down the road in order to give my bet sufficient time to work itself out. It’s sort of like betting on the Superbowl. You might think your team will win the game, but you’re not so sure they will be ahead at the end of the first quarter. Hence, the oft-repeated adage: “Markets can stay irrational longer than you can stay solvent.”

The jury is still out on whether I will make any money on this trade. On Friday (Aug. 16), GE bounced back and closed at $8.79. Sometime during the day, with the stock trading around $8.70, the option trade was approximately valued at about $0.60 or so for a net gain of about 200%. Not bad for a one day investment (err, bet). That means if you invested $1000 (50 option contracts), you now had $3000 on paper. Good sense would suggest that I take the profit and run. But I let greed get the better of me. With four months to go before option expiration, I figured why not let it run a little bit. If GE can get back over $9, where it was before the headline scare, this trade should work out to be even more profitable.

Of course, in the “easy come, easy go” scenario,” sometimes the easiest way to lose money is to hold on too long. Today (Monday), GE is hanging in there. But that could change in a heartbeat with the next headline.

Ordinarily, I would not do this type of trade and I certainly would not recommend it to anyone. But this was a circumstance where the market reaction to the headlines appeared to be over the top crazy and I figured things would settle back to normal in a few weeks. Of course, I could be dead wrong. So again, this was a pure gamble.  In a worst case scenario, I'll own GE at $6 (actual cost basis will be $6.20 if you factor in the net cost of the option contracts).

I look forward to those commenting with any advice or suggestions, particularly with respect to whether I should close out the position or hang on a while longer.

Disclosure: I am/we are long GE options.

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.

Additional disclosure: I am not an investment professional, have no special knowledge and make no representation that the information presented herein is accurate or applicable to any individual. Each person is advised to consult his/her own financial advisor regarding his/her own particular investment situation.