Tuesday, May 4, 2010

Goldman Sacked

Thus far I've avoided sticking my neck out and jumping into any GS positions. With the drama unfolding day to day and news driven movement it's been tough to make heads or tails of Goldman's price action. Fortunately, options offer the versatility of making hedged bets with a wider profit zone than buying or shorting stock outright. Friday night's Option's Action threw out an interesting trade idea to exploit a potential bounce back in Goldman's stock price as well as take advantage of elevated option premiums. Let's breakdown the suggested ratio spread.

Buy 1 Jun 155 call for $5.60 and sell 2 Jun 165 calls for $2.80 apiece. Since the credit received from the short calls is sufficient to pay for the long call, the trade is entered at zero cost. Now, keep in mind zero cost does not mean zero risk. Due to the extra short call, the upside risk can become substantial and your broker will hold aside margin. Consider the risk graph:


[Source: MachTrader]

First off, notice how a decrease in volatility shifts the risk graph upward thereby increasing one's profit. The sweet spot of the profit zone at expiration is between $155 and $175. The most advantageous aspect of the trade structure lies in the absence of downside risk. Thus if GS continues its bearish ways you need not worry about mounting losses. The upside risk could become a problem, but I would be surprised if GS reclaims $175 over the next month. Though this trade structure succeeds in exploiting some type of minor bounce, I'm not sure it's the best play if my objective were to exploit the elevated volatility. Currently downside puts are trading at higher vol levels than upside calls, so traders may consider experimenting with some type of OTM put ratio spread such as the one highlighted in Volatility Spike and Ratio Spreads.

For related posts, reader's can check out:
Gaming the Selloff with Put Ratio Spreads
Gaming the Gold Bugs

2 comments:

Anonymous said...

Hey Tyler,
I would love to see a post on probably my favorite mainstream stock story. The battle between Jim Cramer and John Stewart. It's absolutely EPIC. I would like to see your views on the subject, on Jim Cramer, on Stewart's opinion, and I am dying to hear other people's opinions on the subject. Here's a link to a video, you may be able to find a better video for the post.

-Chris

how to trade stocks for free said...

Very interesting ! I think that a certain state of mind is necessary in order to invest and fructify one's profit. Economics are determined far more by power than by supply and demand.