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Could there be a Christmas rally this year after all? Will everyone spend Kevin’s bonus on presents to stimulate the economy now that interest rates and the price of fuel are still dropping? If so, where better to take advantage of it then with one of the big retailers.
Well, there’s no guarantee that a rally will happen, but I’m going to jump on the band wagon with a low risk, bullish options trade on Woolworths (WOW).
This company has held up well during the market turmoil and is currently trading in an Elliott Wave sideways pattern after coming off its recent lows. See Chart 1:
click to enlarge
I have chosen to trade WOW with an Out of the Money Calendar spread using Call options. I am buying the March 09, $28 contract because I believe that WOW has the potential to trade back up to this price over the next 2 months and I want to use longer dated options to give myself time to be right.
The problem is that options are still expensive due to the current implied volatility levels. So, to offset a lot of the cost of this trade I’m going to sell the February 09, $28 Call contract and create a Calendar spread.
The actual order that I give to the broker will be this.
Buy to open 1 March 09, $28 Call contract and at the same time sell to open 1 February, $28 Call contract for a debit of 35 cents. This means that I’m not concerned with what price the individual contracts are, as long as I only pay 35 cents for the spread. The trade will actually cost me $350, as one contract contains 1000 shares.
Now, how do I work out easily what the profit is likely to be if I’m right and WOW is trading around the $28 level when my short February options expire? The process is fairly simple, at that time; my long options will still have 30 days to expiration and are basically at the money.
To get a reasonable idea of my profit then, I just need to look at what the current January 09 $25.50 options are worth now, to see what 30 day, at the money options are worth. In this case that’s about $1.25.
This means that I can expect to make around 90 cents ($1.25 minus the 35 cents I paid originally) or $900 per contract profit. This is supported by the risk graph in Chart 2:
click to enlarge
The initial trade plan is simple. The best outcome would be to have the February contract expire worthless and then sell the March contract for a profit.
However, should WOW rise above the $28 level, I would have to make a different adjustment. This would probably involve buying back my short position and then deciding whether or not I would sell my long position at that time. How I decided to adjust the trade would be determined by my analysis of where I thought WOW was likely to go next.
That’s the beauty of options trading, the risk is normally low and there is more than one type of adjustment that can be made. I will explore some of these alternatives in a future article should WOW rise above $28.
Remember, you always have options,
Ken Paddison
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