DB,
The insurers have taken a huge hit, and some would appear to be guilty by association; others might be guilty to the core. The options part of it is easy and can be done by anyone with an OptionsXpress account (I recommend these guys as the interface is very user friendly and logical; other more sophisticated options sites exist out there but I haven't gotten to the point where I want to pay for an Optionetics membership or switch my allegiance to Thinkorswim.com. Yet).
The hard part, as always, is to come up with the view. Once you have "view" on the stock, its direction and its timeframe, options will mint you money. Get it wrong and, well, it won't mint you money.
Let's assume that you have decided that HRH, an insurance broker, has gotten unfairly slammed by "l'affaire Spitzer" and will be trading back at 36-38 within 6 months (April 05). That's good, because April 05 are the furthest traded options for HRH.
(You could spend $31,720 and buy 1,000 shares of HRH right now; to me, just buying the stock (in a call option transaction) is always the first paradigm.)
Well, you could simply buy 10 April 30 calls which would give you the upside from $30, for $3.80 per share, or $3,800 (commissions with OX are, thankfully, pretty small, for me they are only $12.50 per 10 contracts, so close to negligible for positions like this).
Now, if HRH trades up to $36 by February, your stock paradigm has gained $4,280, a gain of 13.5%. You sell and are happy.
Your call position is now worth about $6,600, a gain of $2800, a gain of 73%, you sell and are happy. (You can adjust this to equalize the "gains" by buying more contracts, say 15, risking $5700, but gaining $4200 (still 73%, though).
From a risk/reward point of view, in stock you have used a lot of capital ($31,720) to get a 13.5% gain over 4 months or so; with the straight call position you have used much less capital, say $5700, to get a similar dollar amount gain and a terrific percentage gain.
Another way to play it is to obtain an option spread position. For me, if I could get to a "view" on HRH, then I might 1) buy a spread position for 15 contracts of long the 30 calls and short the 40 calls or 2) do the same transaction but try to leg into the 2nd half of it, that is buy the first part and have an order to sell the April 05 40 calls at a somewhat higher price.
1) In the first, straight spread t/a, I buy the 30 calls at 3.8 and sell the 40 calls at 0.35, which means I only pay $3.45 per share to own HRH between 30 and 40, the $10 of the spread. If HRH closes at 41 or above in the 3rd week in April I pocket $10. A $10 return on a $3.45 investment, for 6 months, is 189%. Not bad. [the truth is if HRH got above $40, I would close out the spread at 8.90 or 9.00--I'm no fool.] Total cost for 15 contracts is now $5175 (not $5700).
2) By legging in I buy the 15 April 05 30 calls at 3.80 NOW, but wait and hop that the stock will rise a bit and I can sell the April 40 calls NOT for 0.35 each, but for $1.15. If HRH stock can rise to 33 and/or volatility rises, this can happen quite easily. So I sell the April 40s for 1.15; now my spread has only cost me $2.65, or a total of $3,975. I think of it this way, I own the upside, up to $10 worth, of HRH, now, for $2.65, so my reward risk is $10 : 2.65. If HRH closes at $38 in April, my position will be worth $8, on an investment of $2.65, or a 200% gain.
I often think of these spreads in boxing terms. You decide which way the stock is going to go, and when, and you want to buy the "main event", which is expensive (whether a put or a call). You then look to sell the "undercard" to cut your costs. You still want to own the upside of HRH above 30 for the next 6 months, the only question is cost: will it cost you $31,720 (stock), $5700 (calls), $5175 (call spread), or $3975 (call spread, legged).
Of course there are risks which I don't have time or space to go into, but remember that the calls, or the spreads, act as their own stop-loss orders to a certain degree. I have also simply outlined vertical spreads (same expiry on both options); it is possible, and even more risky, to try to own the longer term option (the main event) and sell a shorter term option (the undercard) against it, two or three times if possible.
But for now, this may be more than you want to know. What I want to know is which of the insurance brokers, health companies are innocent?
Kb |
