Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

Make A Decent Return With GoPro Next Week

As Horizon Pharma (HRZN) went up today by almost 5%, my trade gained a return, as the value of the ATM puts I sold decreased. Basically, that covered sale was attractive because the put options' implied volatility rocketed, making them expensive for the buyers. Now, as the price of the underlying increased, not only the at-the-money options moved out-of-money but they also lost a bit in implied volatility. This was indeed a good call.

Today, I would like to focus on GoPro (GPRO). The similarity between this trade and the Horizon Pharma idea is that they both involve stocks that moved violently in a very short period of time (a trading session). The difference is that they moved in different directions: Horizon Pharma crashed by over 25%, while GoPro gained almost 20%. Both instances increased implied volatility for the derivative contracts in question. This means that, other things being equal (duration, strike prices, interest rates, etc.), these options are now more expensive. However, contrary to the Horizon Pharma's idea, I am not expecting GoPro to go in a rally anytime soon. The company is reporting earnings in eleven days (April 25, 2016). Unless the news are really good and ground-shifting, I do not think the stock will start an ascend. Based on the most recent price dynamics prior and immediately following the latest quarterly report in February, the stock is unlikely to show any more large movements in either direction. In fact, a careful eye notices that the stock moved in the $10 - $14 range over the past three months:

I have also noticed the GoPro's options have become quite expensive relative to historical volatility due to the spike in price of the underlying today. Look at the price table for the options expiring a week from now:

(Source: TD Waterhouse)

Specifically, choose the $14 ATMs, for example. If you add the "last" prices for the call and the put and the divide the result by the current price of the underlying (the stock closed at $13.90, you will notice that the straddle is worth about 10% of the current price. Annualized, this result comes to a staggering figure of 158% per year! On a weekly basis, which is more relevant to us, the implied volatility exceeds 24% over the next six trading days. Even though I do not have a crystal ball, I think the likelihood of such a swift movement in price prior to earnings is unlikely to occur. Hence, I suggest selling the straddle.

It is always a bad idea to be exposed to unlimited risks, which is the case with options selling. Hence, I recommend buying out-of-money options (I am eyeing the $16 call and the $12 put). The result of this combined trade is a net credit position of $1.20 per contract. This is also the maximum return the seller can realize. The risk-return profile is given below:

(Source: optionsprofitcalculator.com)

According to the calculator, the maximum loss with the trade is about $0.80 per contract, while the gain is limited to $1.20 per contract. In percentage terms, this amounts to a nice 8.5% return in just six days! I find this very compelling. What do you think?