Arcángel de Jesús Montoya
3
All posts from Arcángel de Jesús Montoya
Arcángel de Jesús Montoya in Money Trafficking,

My Next Speculative Contrarian Trade: Linn Energy

With the profits from my last successful trade, I feel that my risk appetite has grown significantly. It turns out that selling short-term options on battered stocks is really a strategy that can work in the long-run (after all, people are always overreacting to bad news, especially on the market). Today I am eyeing Linn Energy's options expiring this Friday (April 15, 2016):

(Source: TD Waterhouse)

The $0.50 options are currently in-the-money. With only four days until expiration, there is virtually no time value on the options. So why am I thinking about selling them? Well, there are three reasons, actually:

(1) By selling options, I immediately pocket a premium. By doing so, I know what my maximum return and loss are;

(2) By selling options, I know that I am not going to be "stuck" in a losing trade. Selling puts means that I am essentially long stock. If I decided to buy the stock, and the market went against me, I would have been tempted to "wait it out". Because options have limited duration, I will realize my gains/losses in a timely manner;

(3) The $0.50 strike is the lowest strike available. I would love to capture time value but it is not possible in this case.

The stock has been pretty volatile since the year-start:

(Source: Google Finance)

This volatility has obviously affected options pricing which is definitely beneficial to option sellers:

(Source: author's calculations)

Notice the obvious overpricing of the put options (compare to the midpoint between bid and ask in the first table).

I am almost certain that these options are going to end up in-the-money at expiration because the $0.50 options' Delta is showing that there is a 75% chance of them remaining in-the-money:

(Source: author's calculations)

By selling the puts, I am definitely getting a $0.20 - $0.23 premium. Because I am essentially shorting the downside, my maximum loss is $0.32 per share (out of my own pocket). On the other hand, I see the probability of the stock going to zero in a matter of days as highly unlikely. Hence, I do not expect a loss of more than $0.10 - $0.15 realistically. The premium I just mentioned is the highest possible reward for me - I can only keep it in full if the stock rises above $0.50 per share. I think that keeping half of that premium is a likely outcome.

In short, I expect to make a 50% return on this trade, while risking about the same amount. This may not sound like a very attractive idea but it is extremely short-term, and this is a key factor for me for this type of trade.

For dessert, I have found a great anecdote about historical analyst rankings on this stock:

Most recent broker ratings

03/28/2016 – Linn Energy, LLC had its “focus stock” rating reiterated by analysts at Scotiabank.

02/23/2016 – Linn Energy, LLC had its “sell” rating reiterated by analysts at UBS. They now have a USD 0.15 price target on the stock.

02/18/2016 – Linn Energy, LLC was downgraded to “underperform” by analysts at Wells Fargo.

02/12/2016 – Linn Energy, LLC was downgraded to “sell” by analysts at Citigroup.

02/08/2016 – Linn Energy, LLC was downgraded to “underperform” by analysts at Raymond James.

02/05/2016 – Linn Energy, LLC was downgraded to “sell” by analysts at Ladenburg Thalmann. They now have a USD 0.5 price target on the stock.

02/05/2016 – Linn Energy, LLC was downgraded to “sell” by analysts at Stifel Nicolaus.

12/18/2015 – Linn Energy, LLC had its “hold” rating reiterated by analysts at Barclays.

12/01/2015 – Linn Energy, LLC had its “underperform” rating reiterated by analysts at FBR Capital Markets. They now have a USD 1.5 price target on the stock.

09/11/2015 – Linn Energy, LLC had its “sell” rating reiterated by analysts at Goldman Sachs. They now have a USD 1 price target on the stock.

08/03/2015 – Linn Energy, LLC was downgraded to “sector perform” by analysts at RBC Capital. They now have a USD 5 price target on the stock.

07/31/2015 – Linn Energy, LLC was downgraded to “underperform” by analysts at JP Morgan. They now have a USD 5 price target on the stock.

07/31/2015 – Linn Energy, LLC was downgraded to “underperform” by analysts at Credit Suisse.

06/01/2015 – Morgan Stanley began new coverage on Linn Energy, LLC giving the company a “equal weight” rating. They now have a USD 11 price target on the stock.

05/15/2015 – Linn Energy, LLC was upgraded to “buy” by analysts at Zacks. They now have a USD 14 price target on the stock.

(Source: risersandfallers.com)

Kudos to Credit Suisse for being first on the SELL recommendation. Zacks, hire new analysts.