An interesting spread was initiated in Chinese Internet company Sina.com Friday. Shares were up $2.25 to $48.45 on the day, and a January 57.5 – 62.5 call spread traded on the stock for $1.28, 2870X on ISE. The investor bought the 57.5s for $4.10 and sold the 62.5s at $2.82. A customer bought the spread to open a total of 3500X, according to data from the ISEE. The bullish play on SINA comes as shares try to rebound from a 56 percent nosedive in a little less than a year. It’s a bet on an aggressive rebound through the rest of 2012.
In a bull call spread, the strategist is buying a call and selling a higher strike call. Writing the higher strike call reduces the cost of the trade and will hedge some of the risk associated with time decay. The trade-off is that, if the underlying moves beyond the higher strike call, there is limited upside because if the higher strike call option is in-the-money at expiration, assignment comes into play and the position has reached its max profitability. The best gain from a call spread is the difference between the two strikes minus the debit. The max risk is the debit paid. The breakeven at expiration is equal to the lower strike plus the debit.
In this case, shares are trading for 48.45 and SINA Jan 57.5 – 67.5 traded for 1.28. The risk to the trade is the debit paid, or1.28 if shares hold above the higher strike or 18.7 percent above current levels . The breakeven is equal to the lower strike price plus the net debit, or 58.78 and about 19 percent from current levels. The max profits happen if shares rally above the higher strike and equal the diff in the strike prices minus the debit, or 3.72. The OptionsXpress payoff chart shows the risk-rewards and probabilities of success graphically.
Trade Idea – SINA Jan 57.5 – 67.5 Stoploss=Stock falls below $40 or 50% of premium
Bias = Bullish
Risk = Debit=1.28 Target=50% Increase in Premium
Reward = Diff in strikes – debit =3.72
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Category: Trading Education
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.