Category Archives: OPTION TRADING

CATERPILLAR (CAT)

catCaterpillar [stock_quote symbol=cat] what can I say. What a comeback! Was anybody watching premarket trading? Down after an earnings warning was announced this morning (as it should have been) and then up all day! Caterpillar announced a quarterly Q1 profit and sales warning adjusted EPS (earnings per share) in the 65 to 70 cents per share range instead of the streets estimates of 95 cents. This was terrible and should have caused the stock to tumble, but instead it closes up $1.56 or 2.10%. Incredible…

BOTTOM LINE

The bottom line is with copper, oil and other commodities rising and miners needing equipment Caterpillar is bound to go higher. The short interest was high, almost 7.40% as of the end of February and again, more short covering today I’m sure.

WHAT DO YOU DO?

You should have bought the stock back at $58.00 let’s be honest!! Now? Your only real choice is cash-secured puts. Maybe you’ll catch a dip, get exercised and acquire some shares at a discount. Otherwise, you can still make money as it sits around close to $75.00 and probably continues upward gradually.

Currently Caterpillar is paying $3.08 per share or 4.25% dividend yield annually and is trading at 21.58x forward earnings. Upcoming earnings announcement will be April 22, 2016.

RECOMMENDED TRADE – FAST MONEY

SELL the MARCH 24 2016 74 PUT for .42 cents per contract (if it dips slightly on Friday you can probably get .45 per. If you sold 15 contracts (1500) shares you would need $111,000.00 liquid cash as collateral and your income premium for one (1) week would be $630.00 at .42 cents per. That’s a .00567% gain for one (1) week or 29.5% return annualized. If Caterpillar dips below $74.00 you could get exercised and acquire the shares for $73.58 per share – not bad.

RECOMMENDED TRADE – SLOW MONEY

SELL the MAY 20 2106 72.5 PUT for $2.39 per contract (if it dips slightly on Friday you can probably get it for $2.40 per. If you sold 15 contracts (1500) shares you would need $108,750.00 liquid cash as collateral and your income premium for sixty (60) days would be $3,585.00 at $2.39 per. That’s a .03296% gain for sixty (60) days or 19.8% return annualized. If Caterpillar dips below $72.50 you could get exercised and acquire the shares for $70.11 per share – really not bad! The $3,585.00 equates to $1,792.50 per month income or roughly $59.75 per day while you wait. Again, not bad.

 

NAT TRADE ROCKS!

See what I did with the title? Little play on words. Ok, so sue me, it’s 3:30 AM again, and I can’t sleep. I was just tossing and turning thinking about Nordic American Tanker [stock_quote symbol=nat] when curiosity got the best of me. So here I am doing a little research.

If a dip is truly coming, which I do believe it is, I must to be prepared. I currently hold a sizable position in Nordic in my primary portfolio long-term and, for the right price, I would love to add to that position. Therefore, I’m going to lay out my thoughts and ideas and maybe they will benefit the masses.

OBJECTIVE

To add 10,000 shares to an existing stock position in Nordic American Tanker long-term.

PRICE TARGET

I doubt, even with a dip, we will see $10.90 per share again anytime soon. I could be wrong, but given the trading price over the past few weeks we would have to see a complete market meltdown for this to occur. It’s not impossible, just not probable. However, I want to pay somewhere in the $10.50 – $11.50 per share range or die trying…

EXCECUTION

The closing price for Nordic on Monday was $13.44 per share. Looking through the option list at the MARCH (10 days to expiration), APRIL (38 days to expiration) and JULY (129 days to expiration) options we see pricing as follows:

MARCH $13 STRIKE PUT – $0.35 per contract – 10,000 shares (100 contracts) = $3,500.00 premium or $350.00 per day until expiration. Total per share price if exercised: $12.65. Total ROI option only: 2.7%

APRIL $13 STRIKE PUT – $0.75 per contract – 10,000 shares (100 contracts) = $7,500.00 premium or $197.00 per day until expiration. Total per share price if exercised: $12.25. Total ROI option only: 5.8%

JULY $13 STRIKE PUT – $1.90 per contract – 10,000 shares (100 contracts) = $19,000.00 premium or $147.00 per day until expiration. Total per share price if exercised: $11.10. Total ROI option only: 14.6%

For comparison let’s look at the $12 strike for the same periods:

MARCH $12 STRIKE PUT – $0.15 per contract – 10,000 shares (100 contracts) = $1,500.00 premium or $150.00 per day until expiration. Total per share price if exercised: $12.85. Total ROI option only: 1.2%

APRIL $12 STRIKE PUT – $0.40 per contract – 10,000 shares (100 contracts) = $4,000.00 premium or $105.26 per day until expiration. Total per share price if exercised: $12.60. Total ROI option only: 3.1%

JULY $12 STRIKE PUT – $1.35 per contract – 10,000 shares (100 contracts) = $13,500.00 premium or $104.65 per day until expiration. Total per share price if exercised: $11.65. Total ROI option only: 10.4%

ROI based on $130,000.00 total investment and option transaction only. ROI does not include stock gains or losses or annual dividend yield.

As you can plainly see the $13.00 strike pays more in premium and offers a larger ROI than the $12.00. More importantly with this transaction: the $13.00 strike actually gets us closer to my price per share target range than the $12.00. In fact, the JULY $1.90 looks perfect and not because of the high premium. Look closely and you will see the per-day profit on the premium is actually much less for the JULY than the MARCH.

The per-day profit is not a commonly used technique in determining the proper trade. However, I often use it to help determine the effectiveness of waiting and as a helpful visual comparison of trading vs. my real job. I know how much, on average, I net per day with my real job and if I can match it trading even better! It’s a simple tool for me, that’s all.

If I wasn’t concerned about purchase price per share (if exercised) I would definitely do the MARCH knowing that I would have a better chance to rinse and repeat for greater annualized returns due to the short expiration, and I’m banking it per day. However, I’m not interested in the short-term profit, I’m interested in potentially being exercised and acquiring the actual shares of stock at the discounted price. The longer expiration provides more time for things to go wrong for the buyer (and the market) increasing my chances of being exercised. Strategy my friends, strategy.

The JULY $13 STRIKE PUT for $1.90 per contract offers the best per share price of $11.10 if exercised. If the stock continues up I will make money. If the stock comes down I will make money. If the stock stays where it is I will make money. If the stock falls through the floor I will make money and possibly acquire the shares. There is no downside to this equation. No risk for me – as the seller.

CONCLUSION

If the intent is to possibly acquire additional shares of Nordic American Tanker and to get paid while waiting and patience is a strong virtue then SELLING the JULY $13 PUT (cash-secured) is the right choice. Why did I choose to sell a PUT? Because, if the buyer chooses to exercise his right to “PUT” his shares to me at the agreed upon strike price, I will then be the holder of the shares. That is my ultimate goal – to own more shares and have zero risk while trying. If the buyer does not exercise or I am not “assigned” (another word for being exercised) then I collect the premium only and start all over once the option expires on the third Friday of July 2016.

For clarification I will break it down even further (I know when I first started, I loved as much detail as possible):

SELL 100 (10,000 shares) of the JULY 15 2016 13 PUT with an auto limit-order at $1.90 per contract. Total premium $19,000.00. Total collateral $130,000.00.

You can make this trade with as little as $30,000.00 – $40,000.00 in your account, but I do not recommend this. The safest way to handle is to have slightly over $130,000.00 in cash in your account to cover the entire trade regardless.

If you believe NAT will continue to dip a little this week you could use $2.00 per contract and possibly make an extra grand. It’s always amazing to me how often a limit order will hit a number I choose randomly during the day. Sometimes I will place limit orders with numbers nowhere near where I want to be just to see if I can get it and they will indeed execute eventually. Fun to play with that, especially when you’re right. I have always been quite good at “feeling” the right number, you just have to be confident and let it work itself out. IF, at 7 AM (central time), when pre-market trading begins you see things heading down or that it’s going to be a “down” day I would definitely increase the limit order to $2.00, maybe even $2.25. You never know what the first 15 minutes of normal trading is going to look like and drastic option price swings can and will occur. You might get lucky…

This is an automatic order you can submit and forget. No need to watch it. It will either happen or it won’t and you need to learn to take advantage of being the seller – relax. Being the seller doesn’t require constant attention like being the buyer. If you’re nervous about the price per contract submit an order for 50 contracts at $1.90 and another 50 at $2.10. Learn to be flexible, flexibility can be lucrative.

Once executed you will be short $19,000.00 ($20,000.00 if you waited for $2.00 per contract) meaning the option will initially show a negative number and the only thing deducted from your cash balance will be the commission. Don’t panic, this is normal. In this case, the commission will be somewhere in the $100.00 range.

Yes, I will gladly pay $100.00 in commission to make $19,000.00. Never get upset about commissions – without them the brokerage firm would not be able to provide us with such conveniences.

As time passes, and everything being equal, time decay will slowly deteriorate the option value bringing your initial negative short position closer and closer to zero – gradually increasing your account balance in the process. This can happen slower or rapidly depending on the underlying stock movement. If Nordic takes off to $15 per share, the PUT option will become less and less valuable very quickly and, thus, you will become more and more profitable very quickly.

The opposite occurs if Nordic goes down, but remember, no matter what you get the entire premium at expiration. You will never actually “lose” money. You may get exercised and pay $13.00 per share for a stock that could be worth $8.00 at expiration, but that is the only real risk and at that point you do own the shares, you kept the premium and can sit on the stock (collecting the dividend and selling covered calls to subsidize loss) forever if you want. By expiration, if all goes well, your account balance will be $19,000.00 ahead and the option will expire. The end.

If Nordic drops through the floor and you are exercised, you will receive 10,000 additional shares paying $130,000.00 to the buyer of the option (the person that exercised) because you agreed to pay him $13.00 per share, and you will keep the premium as well. Thus, you technically paid $110,000.00 or $11.10 per share. See how this works? Win-win. Given the fact you actually paid $13.00 per share for the stock (before the premium) the dividend return would be 13.2% annually. It’s not the 15% I would like, but it’s not bad either.

I hope you have enjoyed my Nordic trade and you bet your ass I’m doing this in the next trading session! Please let me know if you have any questions or comments or find any errors in my calculations. It is now 5:15 AM and sometimes my eyes glaze over and I start missing things. It’s easy to do…good luck!