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Lockheed Martin Diagnal Call Spread

|Includes: Lockheed Martin (LMT)
Summary: On 10/15 PT entered into a second diagonal call spread, this time using Lockheed Martin Corporation (NYSE:LMT) stock, which consists of (i) buying 15 March 70 calls, (ii) selling 5 December 75 calls, and (iii) selling 10 December 80 calls, for a net debit of $8615.16. As of 10/16, OptionsXpress expresses the profit/loss profile of this position in the blow chart (which, as discussed in the prior post, should be taken with a grain of salt b/c of an unrealistic IV assumption).

Break-Even Price: Likely around 73 depending on IV at December expiration.

Maximum Profit Price: $80 per share. Note that unlike the McDonald's (NYSE:MCD) spread, this spread doesn't include additional long calls to capture upside - which sacrifices downside protection and time decay on the MCD spread.

Potential Downside: Downside is limited to the net debit, or $8615.16.

Greeks: As of 10/16, position delta was 468, and gamma -26. Position theta was around 10.7, and will increase as we near December expiration subject to a changing stock price. Vega was substantial at 93.3. For more information regarding the "greeks" please see the McDonald's post.

Rationale: Similar to MCD, I believe LMT is a compelling diagonal call spread candidate. IV on the March calls (and all LMT calls) has declined drastically in recent months. Given concerns regarding the current administration and the federal government's budgetary restrains, the stock trades at a historically low multiple of both trailing and projected forward earnings, and offers a substantial dividend yield. LMT stock has shown strong support in the 70-75 range (which makes sense fundamentally), and has come down modestly over the last few weeks after flirting with the $80 mark. Look for LMT stock to move relatively substantially next week upon the 10/20 earnings announcement. Following the announcement, the position will be reevaluated.

In the event LMT stock declines drastically over the next three months, I will look to add exposure so long as LMT's fundamental strength remains intact. I don't, however, believe LMT has break-out potential given the above mentioned concerns and believe it will likely stay range bound into the foreseeable future. The optimal turn of events would be for LMT to stay in the mid to high 70s until December expiration (or at least end there), allowing me to roll the December 75 and 80s into January or February 80s while keeping the March calls.

Note that I've chosen to stagger the expiration of the near month calls in my two diagonal spread positions between November and December, a helpful hedge against market volatility.

Update: Following a poor outlook for FY 2010 earnings provided by management on the recent earnings conference call, LMT's stock price fell considerably on 10/20. In light of this price movement, I defensively repositioned the LMT spread by (i) buying back the 10 December 80s, and (ii) selling 10 December 75s, for a net credit of $1100 less commissions. The position's max profit point is now $75 as opposed to $80.

Disclosure: Long LMT.