By Michael C. Thomsett , contributing writer
(For those familiar with options trading and authorized to transact the following level of transactions)
Research in Motion (RIMM) alert: On June 1, 2011, a SmartStop was triggered.
The price of this stock in your SmartStops portfolio has fallen to the point where it’s triggered today’s SmartStop.
Note the last two sessions have developed one of two bearish alerts, confirming the SmartStop trigger. The full session was black followed by a downside gap. This may develop into one of two strongly bearish indicators. First is the side-by-side black lines, which will develop if a third session is also black and does not rise to fill the gap. Second is a downside tasuki gap, which develops if the third day is white and moves up and into the gap, but does not close it.
In either event, the confirmation of the SmartStops alert in the form of bearish signals may cause traders to take appropriate action. This may consist of one of three recommended options-based trades:
1. Buy a protective put at 40. This decision makes sense if a trader’s original basis is lower than $40 per share. If the price declines into the money, the put can be closed to offset losses in the stock with increased intrinsic value; or it can be exercise to sell shares at a profit. The profit will be equal to the difference between the strike and original basis, minus the cost of the put. With the stock at $41.16 as of this writing, the June 40 put is valued at 1.41. If traders consider the downside risk short-term, buying this put makes sense. If considered longer term, one of the two following strategies makes more sense.
2. Open a collar using the 42.50 call and the 40 put. The June collar based on these values involves the long 40 put at 1.41 and the short 42.50 call at 1.36. Net cost of the collar is 0.05 plus trading expenses; but it protects against downside protection just like a protective put but for less cost.
3. Open a synthetic short stock position using the 42.50 positions. This involves a long put and a short call. The 42.50 put is at 2.70 and the call is at 1.36. The net cost for the synthetic short stock using June contracts is 1.34. The same strategy using September 42.50 contracts combines the long put at 4.50 and the short call at 3.45, for a net cost of 1.05 but a much longer period of downside protection.
Keep the probabilities on your side.