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Follow-Up on Green Mountain Coffee Roasters:
This is what I wrote two weeks ago – “I bought a diagonal call spread, buying GMCR Jun-14 70 calls and selling Feb1-14 80 calls. The spread cost me $9.80 at a time when the stock was trading at just below $80. If the stock moves higher, no matter how high it goes, this spread will be worth at least $10 plus the value of the time premium for the 70 call with about 5 months of remaining value, no matter how much IV might fall for the June options. The higher the stock might soar, the less I would make, but I expect I should make at least 20% on my money (if the stock moves higher) in 17 days.”
While the spread could not lose money no matter how high the stock might go, this was not a great investment to make if you were as bullish on the company as I was. The more it rose above $80, the less it would make. A 40% move on an earnings announcement is highly unusual, but that is what happened.
When the stock traded down a bit last Friday, I sold that spread for $11.00, making $1.20 less commissions of $.05, or $1.15 ($115 per spread). That worked out to about 12%. I will never complain about making a gain, but this was a major disappointment when I was so right about how the stock would move after the announcement. It just moved a whole lot more than I expected.
Last week I told you about another spread I placed on GMCR before earnings. This was a calendar spread (same strike, buy one further-out month and sell a shorter-term option). The trick was to pick the strike price you believed the stock would end up after the announcement. With the stock trading at $80 before the announcement, I suggested to pick the 85 strike (buying April calls and selling March calls for about $.80 per contract).
The further away from $85 the stock traded after the announcement, the less well the calendar spread would do. On the other hand, if you correctly picked the price, you could make 200% or more on your money. When the stock soared $30 and was trading around $110, this spread lost about half its value (I actually bought 100 of these spreads at the 90 strike instead of the 85 strike, but this spread did not do much better – I am hanging on to most of the contracts just in case it reverses direction over the next 6 weeks).
Another spread which I did not report to everyone (except my paying subscribers) was a vertical put credit spread, selling 85 puts and buying 75 puts in the same month. I placed these trades for June, collecting a credit of $5.20, making my investment $480 per spread (this is the amount that would be my maximum loss if GMCR closes below $75 in June). If the stock closes above $85 (which it looks highly likely to do), I will make 108% on my investment. (I also sold similar vertical put credit spreads for both March and June at others strikes, and every spread appears that it will make 70% or better at expiration).
This time around, the calendar spreads didn’t fare well because the stock skyrocketed so high. It is really necessary to guess where the stock will end up with that kind of spread. I was too conservative in my bullishness. Who would have ever guessed that the stock would soar by 40%? Certainly not me. But I was happy that I also bought some other directional spreads that profited from the upward move (these spreads would have done just as well, or better, if the upward stock price move had been smaller).
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