By Chris Ebert
Hain Celestial Group (NASDAQ:HAIN) has a long history of surprising traders, and that includes the normally savvy group known as option traders. This becomes evident when one looks at the performance of one particular type of option trade known as a Long Straddle.
Up until last week, Long Straddles on HAIN, opened 112 days before expiration, were profitable every week in 2012. That is highly unusual given that the sellers of those Straddles have the ability to raise the premium. Yet for the first 40 weeks of 2012 the sellers did not raise the premium sufficiently. They were surprised 40 weeks in a row, and lost 40 weeks in a row - until last week.
HAIN Correction was long overdue
The performance of Long Straddles has long indicated that traders were likely to feel that the stock was due for a correction. With the stock up nearly 100% year-to-date at one point in September, it was clearly over-bought, but the buying continued. The recent pullback off the recent $72 highs should provide some much needed relief.
The current $60 level represents a healthy correction, while a decline to as low as $58 in the next few weeks could occur without much change in sentiment.
Below $58 traders will lose strength in their bullish convictions - as indicated in the Long Call Analysis that follows.
Below $55 traders would be ready for the stock to break out of its current trading range - as indicated in the Long Straddle Analysis.
Below $52 traders would become decidedly bearish - as shown in the Covered Call Analysis.
From a purely option trading perspective it would seem possible that traders may be willing to test the $55 level, as that represents a tipping point for options where the stock will either break out to new highs or break out into a new downtrend. Since that level also marks a major recent technical support, traders may feel a need to see if that support holds before making future trades.
HAIN options analysis
Because option premiums are based on emotions, the profitability of these trades is highly dependent on emotions as well. The profit or loss of option trades can therefore reveal the emotions of traders. If the emotions are known, the decision of when to buy or sell a stock can be made with more confidence. A study of stock options can therefore be helpful, even for traders who do not trade options or understand how they function.
- Covered call performance reveals whether traders feel bullish or bearish
- Long call performance reveals whether traders feel a stock is strong or weak
- Long straddle performance reveals whether traders feel surprised
Covered calls opened with a strike price that is the same as the HAIN share price (often called the at-the-money strike price), and opened a moderately long time before expiration, in this case 112 days, have returned a gain every week in 2012. The profitability of these trades occurred despite several corrections in the uptrend in which the share price declined 20% or more off of weekly highs before resuming the trend upward.
When covered calls are profitable, traders tend to feel bullish. Covered calls are currently profitable with the HAIN share price near $60, and they will remain profitable unless the share price falls below $52 in the next few weeks. A decline below the $52 level in the next few weeks would very likely represent a significant switch to bearish sentiment.
Just because the performance of covered calls indicates that traders are currently bullish does not mean that prices will necessarily rise. It is therefore helpful to look at the performance of another option trade, the long call, in order to determine the strength behind those bullish emotions.
Long calls on HAIN opened at-the-money, 112 days prior to expiration, have also been profitable every week in 2012. When long calls are profitable, traders tend to feel strength behind their bullish convictions. Long calls will remain profitable unless the share price declines below $58 in the next few weeks. A decline below the $58 level in the next few weeks would represent a loss of strength in traders' bullishness.
Even though covered call performance indicates bullishness, and long call performance currently indicates strength behind that bullishness, there is still no guarantee that prices will rise. It is therefore helpful to analyze the performance of a third type of option trade, the long straddle, in order to determine whether traders feel surprised by the current price of HAIN shares.
Long straddles opened by buying an at-the-money call option and a put option, at the same strike price, 112 days prior to expiration have been highly profitable recently. These profits do not represent a normal condition, but instead reveal that the share price moved much further, much faster than many traders expected.
Often, but not always, excessive profitability of long straddles is an indication than many traders may feel that the stock is due for a correction in the current trend. That does not mean a correction is imminent. However, given that many traders are likely to feel surprised by how fast HAIN shares have climbed in 2012, the recent correction was long overdue.
Over the next few weeks, any price of HAIN shares above about $66 would cause long straddles to exceed the maximum 8% profit that may be considered normal. An increase in the share price above $66 in the next few weeks could trigger another correction. Any decline below about $55 would cause those same trades to exceed the maximum 12% loss that is normal. A decline below the $55 level in the next few weeks could trigger a breakout. Such a breakout could either be to re-test the recent $72 highs, or back towards prior support in the $52 range.
Possible option trade based on the options analysis:
While no single option trade is suitable for all traders, the following is presented for consideration. The options analysis shows bullish strength, but also that HAIN was due for a correction. An in-the-money covered call could take advantage of a further correction while still retuning a profit if the correction has already gone as far as it is going.
BUY 100 SHARES HAIN @ $60.00
SELL 1 $55 NOV. CALL @ $6.00
If HAIN shares do experience further correction and decline to $55, the call would expire worthless leaving the shares in place to capture future gains, while the $600 premium would be retained.
If HAIN remains above $55, the 100 shares are sold for $55 per share, and the $600 premium received offsets the $500 loss on the sale of the shares.
Losses are possible if the share price falls below $55, so it is necessary to monitor the trade and cut losses short when necessary.
Note: Performance of option trades is extrapolated where the necessary strike prices and expiration dates were not available in actual trading.
The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book "Show Me Your Options!"
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