CASE STUDY — BTU Jan 30 Long Call — *closed*
The coal space was hot Friday after Arch Coal (ACI) posted earnings that were less grim than analysts feared. ACI is up 24 percent. Alpha Natural Resources was the subject of a bullish combination trade (see today’s ANR color.) Meanwhile, Peabody Energy (BTU) is up 56 cents to $20.17 and recent trades on the stock include a 4000-lot of Jan 30 calls bought for 38 cents per contract. 16,000 calls and 7,670 puts now traded in BTU and implied volatility is easing 5.5 percent to 51.5. Let’s consider the Jan 30 call purchase for a case study and an example of a high risk-reward (read: speculative) play on a beaten-down name.
A long call is a basic options 101 strategy that most people understand. When going long one call option, the investor is basically locking in the right to buy (call) 100 shares for a set price (strike) through a fixed period of time (expiration date.)The risks and rewards of straight call buying are also easy to understand. If the price of the underlying stays below the strike of the call option, the contract is out-of-the-money and, if left open through the expiration, would expire worthless. If so, any premium paid is lost. That’s the maximum risk associated with call buying.
In this case, shares are trading for20.17 and BTU Jan 30 Call are trading on the stock for a VWAP of0.38. The risk to the trade is the debit paid, or 0.38 if shares hold below the 30 strike or 48.9 percent above current levels. The potential profit is unlimited as shares move beyond the strike price of the contract and the upside breakeven is equal to the strike price of the call plus the net debit, or 30.38 and 50.6 percent from current levels. The OptionsXpress payoff chart shows the risk-rewards and probabilities of success graphically.
Case Study- BTU Jan 30 Call
Bias = Bullish
Risk = Debit=0.38
Reward = Theoretically unlimited
Breakeven=strike+debit=30.38
Download PDF Version —> BTUJan30Call
CASE STUDY CLOSED 8/1/2012
Category: Trading Education
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About the Author (Author Profile)
Frederic Ruffy is a well-known trader, writer, and strategist who has spent years educating investors and creating intelligent, insightful, unbiased market observations that are frequently cited by the Wall Street Journal and other financial publications. As senior analyst, Fred provides frequent and regular notes and daily updates for activity of interest.
