How would you play this?

Stock XYZ is at $91

You think there is a small chance the stock will move up in the next two weeks and a very strong chance the stock will move up in the next 45 days.

Then you expect the stock to drift back down to 90.

If in the next 45 days there is a:

5% chance it will go higher then 115
15% chance it will go higher then 110
25% chance it will go higher then 105
50% chance it will go higher then 100
90% chance it will go higher then 95


How would you set up this option trade?

 

If you're that confident, load up the truck with 90, 95, and 100 calls 2 months out, and pick up some stock too.

When the stock hits the level that makes you think it's going to go back down, short as many shares of it as you have contracts to cover it. By expiration day, if it's back to 90 as you predicted, cover your shorts, let the options lapse (obviously), otherwise exercise.

90% confidence is a hell of a lot though.

 

back it up

 

Sorry, I forgot to mention the option premiums.

Let's say I'm buying July options (only because the June options don't have prices yet, and this modeled on something I'm working on now) The prices are:

90C: $7
95C: $4.7
100C: $3
105C: $1.8


90P: $4.9
95P: $7.5
100P: $10.9
105P: $14.8

 

Just take shots

 

You've only got two of the three opinions necessary to trade options:

1) Direction - Up 5+
2) Timing - 45 days
3) Volatility - ?

Earnings in the next 45 days? Acquisition possibilities? FDA approval? How does the IV relate to the historical volatility--higher, lower, trend?

If you don't have a volatility opinion, buy stock or buy deep ITM calls.

Once you have all three opinions, the next question you must answer is:
- risk/reward

If you're 90% sure that it will go up, why are you playing options at all? It would seem you should be willing to take a large risk for such an easy reward.

Options are really only a means to define a complex payoff scheme. You can play it as a long-shot, sure-thing, limited-risk, unlimited-risk, or income-generating position. Your payoff scheme seems simple--you think it will go up. Options really aren't appropriate here.

 

By the way, stock "XYZ" (aka AAPL) has earnings on Wed. IV is *unbelievably* important.

 

1. If I buy calls don't I have a higher return as opposed to buying the stock?

2. Tell me what I'm doing wrong with this scenario. Is there a simpler way to do this or is there a way to get a better return with/or less risk?

Sell 100 Puts @ 10.90
Buy 85 Puts @ 2.95
Net Credit = 7.95
Break even point = 92.05
Max Loss = 7.05
If option expires at:

$85, the return = -7.05
$90, the return = -2.05
$95, the return = 2.95
$100+, the return = 7.95


or

Sell 95 Puts @ 7.50
Buy 85 Puts @ 2.95
Net Credit = 4.55
Break even point = 90.45
Max Loss = 5.45

If option expires at:
$85, the return = -5.45
$90, the return = -0.45
$95+, the return = 4.55

 

I know but what's going to really move this stock is the iPhone release.

 

Yeah, I figured it was AAPL..

but those premiums are pretty high, since you're not so certain about the stock moving over 100, I'd say go for deep ITM calls or just buy the stock. If you buy ATM or close to the money calls, the time premiums are huge.