Reverse Iron Butterfly

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Education, Invest, Investing, Investments, iron butterfly, Loss, Money, Options, options strategies, Profit, reverse iron butterfly, Risk, Stock, Stocks, Strategy, Strike Price, Think

Whereas last week I covered a strategy that an investor would use when a low degree of volatility is expected, this week I will be going over a strategy that could be employed when there are expectations of heavy volatility for a stock.  The Reverse Iron Butterfly is the exact opposite of the Iron Butterfly strategy. It is a strategy that would be used if an investor expects the stock to move a lot before the expiration date, but is not sure about which way it may go.

This strategy could be optimal for a stock that is expected to release some very large news or may have an important earnings release date coming up, as the stock could move drastically based on investor interpretation and response to this news.  In order to complete a Reverse Iron Condor, an investor would:

1. Sell a lower strike out-of-the-money put
2. Buy a middle strike at-the-money put
3. Buy another middle strike at-the-money call
4. Sell another higher strike out-of-the-money call

 

Maximum Loss:

Because the investor has sold puts and calls that are further out of the money (and therefore would have lower premiums) and bough higher premium puts and calls that are at the money, he or she would have spent more on buying than gained on selling, and therefore would have an initial payout as compared to a normal Iron Butterfly where they would have had an initial input of cash. This initial payout at the at the money strike, is also the maximum loss obtained for the investor. If the options expire at the original price, then the maximum loss would be achieved.

Any movement away from the initial at the money price in either direction would see the loss decline and move the investor towards positive territory.

 

Example – Ford

For this example we will use Ford and their current options for June 17^th, 2016. As of closing April 5th, 2016 the current price of Ford is $12.77. For ease, the price of Ford will be rounded up to $13.  We will use quantities of 1000 for each option. An investor performing a Reverse Iron Butterfly on Ford could:

 

1. Sell 1000 puts at a strike price of $9 at premium of $0.16 for a total inflow of $160

2.  Buy 1000 puts at a strike price of $13 at premium of $1.46 for total outflow of $1,460

3. Buy 1000 calls at a strike price of $13 at premium of $0.44 for total outflow of $440

4. Sell 1000 calls at a strike price of $17 at premium of $0.02 for total inflow of $20

This would give the investor an initial outflow of $1,720 ($1,900-180). The investor’s maximum loss for this strategy on Ford would therefore be the same $1,720. This would occur if at expiration the price of the stock is $13.

Maximum Profit:

On an ordinary Reveres Iron Butterfly, the maximum profit would occur if the price at expiration is either equal to or less than the sold put, or equal to or greater than the sold call. The Maximum profit would thus occur at $17 or over of at $9 or below. The maximum profit for this strategy would be $2,280. Although this seems like a decent strategy if you expect the stock to have high volatility, it is necessary to analyze the premiums and see if this is truly the best strategy before selecting it.

In this situation, because the difference between the premium on the sold put and premium on the bough put is much larger than the difference between the premium on the sold call and the premium on the bought call, this strategy may not be the most efficient. The sold put is the same price away from the bought put ($4) as the sold call is away from the bought call, but the difference in premiums is much less. This shows that it is likely that investors believe that Ford is much more likely to drop $4 than to increase $4. When analyzing the strategy, it seems pointless in this situation to sell the calls. Because the premium is so low, only $20 would be gained from performing this part of the strategy, and the possible losses if the price is to rise above $17 quickly eliminates the initial inflow of $20. In fact, this only raises the maximum loss by $20 and gives the investor unlimited gain if the price of the stock is to increase. This is demonstrated below.

It thus may be better based on Ford´s options to attempt a different strategy.  Although the Reverse Iron Butterfly could be a way to take advantage of expected volatility for Ford, other strategies may work better as well!

 

Break Even Points (BEPS)

The breakeven points for the Reverse Iron Butterfly can be calculated using the following formulae.

For the upper breakeven point you can take the strike price of the long call and add the net premium paid.

• $13.00+$1.74(per share net premium) = $14.74

For the lower breakeven point you can take the strike price of the long put and subtract the net premium paid.

• $13.00-$1.74(per share net premium) = $11.26

 

Conclusion:

The Reverse Iron Butterfly is a very useful strategy that can be used when high volatility is expected for a stock. However, as we have seen it may not always be the best strategy so it is wise to analyze completely before selecting an investing strategy. This was definitely the case in Ford due to obvious investor sentiment that the stock is not worth $17. Be careful when selecting options strategies, as the market can dictate their usefulness in more ways than one!

 

The Iron Butterfly

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Calls, Investing, Investment Tools, Investments, iron butterfly, Money, Options, options strategies, Profit, Put options, Puts, riesgo, Risk, Stocks

When investing, there are many different ways to bet your money and try to gain income or profit. Normal stock investing is simple but can be quite risky if you pick a loser. Using options can be a much less risky way to invest in the market.  Whereas investing in stocks can bring you great opportunities for profit, they also hold a large amount of risk. If you buy a stock and its price falls to 0, you lose everything that was invested.

In comparison, using a call or put on a stock can lower your total risk as well as be a much cheaper way to make profit. Using options allows investors to have the chance to reap large benefits without putting too much on the line.

Many people use simple call and put options, but there are numerous strategies that can be applied based on different situations and market expectations.

____________________________________________________________________

The Iron Butterfly is an options strategy that consists of four different options. The technique will be demonstrated using options on Bank of America. For an Iron Butterfly, the investor:

1.  Sells an at the money put
2. Buys an out of the money put at a lower price than current price
3.  Sells an at the money call
4.  Buys an out of the money call at a higher price than current price.

This strategy is employed when the investor expects the stock to have low volatility but is not sure of the direction in which it will move. In this situation the investor would make the largest profit if the stock does not move much and would lose the most if the stock moves a lot in either direction.

Example – Bank of America

For this example we will use Bank of America and their current options for May 20^th, 2016. As of closing March 29^th, 2016 the current price of BOA was $13.42. For ease, the price of BOA will be rounded down to $13.  We will use quantities of 1000 for each option.

 

1. Buy put option with strike price of $11 for 08 cents a share ($80 output)

2. Sell put option with strike price of  $13 for 43 cents a share ($430 input)

3. Sell call option with a strike price of $13 for 84 cents a share ($840 input)

4. Buy call option with a strike price of $15 for 12 cents a share ($120 output)

Maximum Profit

The maximum profit for the investor would be obtained if the options expire at the current price. In this situation, there would be no loss as neither the sold call or put would be exercised (and the premium from the selling of these two options would be gained). The bought put and call would also expire worthless for the trader. However, the premiums paid to the trader would be more than the premiums that were paid for the bought options as it is more expensive to buy at the money as opposed to out of the money.

Based on these options, the investor performing the Iron Butterfly would have an income of $1,070 ($1,270-200) after initial transactions. If the price at the expiration date is $13 (ends at the money), then the profit attained is the maximum profit at $1,070.

Maximum Loss

As the price of the BOA stock moves away from $13 in either direction, the investor would lose money until the maximum loss of $930 is attained. This maximum loss first occurs at two points for the investor. It occurs at the price of $11 as the profits gained from the purchased put offsets the loss from the sold put for every cent moved, as well as at $15 where the profit from the purchased call offsets the losses occurred for the sold call.

Break Even Points

The investor in this situation would see profit at any point in-between the two break even points (BEP).

The upper breakeven point can be found by taking the strike price of the short call and adding the net premium received per share

• $13+1.07 = $14.07

The lower breakeven point is found by taking the strike price of the short put and subtracting the net premium received per share.

• $13-1.07 = $11.93

 

Between $11.93 and $14.07, the investor would make a profit in this situation. The Iron Butterfly is a bet used when the investor does not think there will be much volatility in the stock and can be a great way to take advantage of options. Although there is still a possible loss, this strategy hedges against much heavier losses that could be accumulated in other investments and is a much cheaper way to try and gain profit.

Hedging a Risky Bet: Oil and Airlines

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Airlines, American Airliens, American Airlines, Diversification, ETF's, Hedging, Heding, Investing, Jet Blue, Loss, Money, Oil, Profit, Spirit Airlines, Stocks, Strategy, Think

Oil prices have been an extremely hot topic over the last couple months, with differing opinions flying about all over the place. Over the past year, oil has seen historic falls and has gone continued to go lower and lower. Over the last few days, oil prices have increased amid a rally, but how long will this rally really last? Morgan Stanley believes that this rally will not last much longer and that prices will even go lower in the first half of 2015. They believe that Q2 will see the greatest decline with oil prices falling as low as $43 in Q2 of this year. For value investors, this drop in oil prices is a fantastic opportunity to buy, but the question remains…. When should we buy?
Investors believed it was undervalued when prices fell into the 60’s, but prices have just kept on dropping and the early birds are now sitting at pretty decently sized losses. Personally, I do not think that a commodity such as oil has any chance at sustaining this level of prices for an extended period of time, but it is not unreasonable to imagine that prices may hover under the 60’s for some time. It is thus very important to find the correct price at which an investor feels comfortable with buying. It is important to not buy too late when the price has already began to climb, but buying too early could also prove to be a painful decision. With so many differing opinions flying about and nobody really knowing for sure where oil prices will be six months from now, investors interested in taking a chance at buying oil should consider finding ways to hedge their bets.

In the long run it is highly likely that prices for oil will once again go up. Although many analysts’ believe that prices could remain low for an extended period of time, simple economics dictate that at some point prices will rise. Whether this will be this summer when travel traditionally increases or at some other point in the future continues to be unknown, but eventually oil prices will be stipulated by increasing demand and will increase.

One way for investors looking to get into oil to hedge their bets is by buying long into airlines. Airlines and oil prices have an inverse relationship. When oil prices go up, airlines need to pay more for fuel and thus have lowered profits. When oil prices go down such as they have been doing, airlines benefit from decreased costs and are able to increase their profit line. Buying long on airlines while also owning a long position in oil is one technique that allows an investor to protect what some may deem a dangerous position in a volatile market. Airlines have also been doing very well recently this year even without added benefits from falling oil prices. Travel has continued to increase and airlines are packing more and more flights into the day. Airline stocks also tend to have a stronger correlation with falling oil prices than they do rising. Although airlines do face higher costs when oil prices are high, the change in stock prices associated with an increase in oil prices usually are not as large as when oil prices fall.

In this example, I am going to demonstrate how investing in airlines as a hedge against a long position in oil could have proved beneficial over the past year.
In this case, we have two investors. Both investors have $100,000 invested in a long position in the iPath S&P GSCI Crude Oil TR ETN (OIL). Towards the end of June 2014, when oil prices were at their highest point since September of 2013, and amid speculation about what Saudi Arabia may do with oil, Investor A decided he wanted to protect himself in case oil prices dropped lower. To do this, he decided to hedge 75% of his oil position. This is a large portion to hedge, but he also believed that the stocks were undervalued and liked the airline industry in general. Rather than invest in an airline ETF, he decided to pick four three airlines that he felt had the strongest potential and put $25,000 in each. The three airlines in this situation that our investor chose were American Airlines, JetBlue, and Spirit airlines. Investor B chose to leave his portfolio unaltered as he felt that even if oil prices fell, they would eventually return to higher levels.

If Investor B had owned $100,000 in OIL on June 23rd, 2014 when OIL was priced at $25.69 end of day, and had added $75,000 in OIL rather than using the extra money to hedge, he would have had a February 2cnd portfolio value of $81,306.22, which represents a 54% decline in portfolio value. At this point, Investor B would be facing a massive loss which was only made worse by his decision to not diversify or hedge his portfolio.

If Investor A, had owned $100,000 in Oil on June 23rd, and also $25,000 each in Jet Blue, American Airlines, and Spirit airlines, his portfolio value on February 2cnd would have been $144,462.04 which is only a 17.45% decline in portfolio value. Although Investor A would have seen a negative loss as well, his use of a hedge helped him to greatly decrease the loss.
Investor A’s portfolio since June 23rd would be much more stable and would look like this:

Despite a major fall in the OIL stock price, Investor B was able to limit his losses due to his investments in the three airlines.

As risky a bet as oil is at this moment in time, it is wise to look for a hedge to offset any potential losses from decreasing oil prices.

Calls: Taking Advantage of Options

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Advantage, Calls, Investing, Loss, Money, Options, Profit, Puts, Smart, SolarCity, Think

Over the next two weeks I will be informing you about the two most basic options that are available in the options market. Calls and puts are very easy to understand and when used correctly can potentially bring big gains. They can also be combined in many different ways in order to create options strategies such as the ones I have discussed in previous posts. I previously discussed butterfly spreads, bull call spreads, protective puts, and covered calls. These are all very interesting strategies, but what is behind all of them? Basic puts and calls! Today I will be focusing on calls.

Call Options:

A call option is an agreement that gives the investor the right to buy a stock at a specified price at a specified time (or time period). You can either buy a call, or sell a call. We will start with the basic action of buying a call. When you buy a call, you are agreeing to buy the right to purchase a certain amount of stocks at an agreed upon price once a certain at a certain time.  However, as the investor you do not necessarily have to buy the stock at this time. You have the right to buy the stock for this price, but it is not an obligation. Say for example, that the current price of SolarCity Corporation is $70. An investor who believes that the stock is going to rise in price by a lot could agree to buy a call option. He could potentially buy a call option on SolarCity at $80 for October 2014. Once October rolls around, the investor has the right to either exercise his option and buy the stocks for $80 or not exercise.

When would he exercise and when would he not?

If the stock price is over $80 the investor would exercise his right and buy the stocks. He would do this because he would be paying $80 per stock even though the value is higher than $80. His profit from exercising the options would then be the difference between the price he paid and the current value multiplied by the amount of stocks (One call = 100 stocks).  For example if the price was at $88 and he had purchased 10 call options (1000 stocks), then his profit from the purchase of the stock would be ($8 times 1000 =) 8000 dollars.  If the price was below $80 dollars, the options would not be exercised because it would not make financial sense to do this.

Why doesn’t everyone buy calls? It seems risk free!

Because the market is how it is, somebody has to win and somebody has to lose on each transaction. Therefore, there always has to be a way to lose money with each transaction if there is a way to lose money. When somebody buys a call, they pay what is called a premium. This is an upfront payment which allows the investor to obtain this right to buy the call.  The seller of the call in this case would receive an inflow of money when the transaction is agreed upon.   Because of this, the $8000 dollar profit we discussed in the previous passage would not be the final profit. You would have to subtract the initial cash flow (premium) from the profit to determine how much was really made. If the option was not exercised, the buyer of the call would not pay anything else, and would have a loss based on the initial premium they paid. In this case, buying a call at $80 on SolarCity would cost the investor a premium of $5.60 a share, or $5600 overall. Thus if they exercised the option at $88, there profit would be $2400 whereas if the price ended up below 80 and was not exercised, they would end with a loss of the initial premium of $5600.

Selling a call-

Selling a call has the opposite effect of buying a call. We will use the same example to demonstrate this. If I was an investor and had sold the 10 call options to the investor above, my cash flows would be opposite of his. If the price stayed under $80 I would gain the premium that he paid me of $5600. If the option was exercised at $88, I would lose $2400. For both sides of this contract, the breakeven point would be at $85.6 dollars. Every dollar after $80 would result in a loss of $1000 for the seller of the call and a gain of $1000 for the buyer of the call.

Why buy or sell a call?

People buy or sell calls for a couple of reasons. We will start first with selling calls. When you sell a call, you have the option to receive a quick boost of income. If you do not believe the stock will go up, then this could be a great way to take advantage of the possible decline of a stock. It could also benefit you if the price is not expected to go up much. For example, selling a call option on the previous example could be very profitable. If the price stays below $80 by October, the seller of the call would have gained $5600. Even if the price reaches $85.60 he/she would still break even!  For the buyer, buying calls is a great way to take advantage of options if you do not have as much money but believe the price will go up. Because the premium is so high in this example (SolarCity has great prospects), this may be a dangerous play for the buyer. However, if the premium was more reasonable or the price was expected to go up much higher, then this could be a good option to buy, To show this, I will compare buying ten calls (1000 stocks) for $5600 to buying $5600 worth of shares.  This would only buy you 80 shares. If the price rocked to $100, you would gain (100-70) $30 times 80 ($2400) if you held the shares. Alternatively, with the call options you would gain (100-80) $20 times 1000 (shares) or $20,000. Your gains would be nearly ten times larger with options. There is a slight risk of losing money based on the premium, but if you purchase the right calls at the right time, you can make massive gains off of call options.

I hope that this post has helped you to understand call options, but just to make sure I have added a graph which shows both the profits for buying a call and selling a call. Keep in mind that a long call means buying a call, and a short call means selling a call.

As you can see, the profits are the inverse of the other.

 

 

Shorting Stocks: When Prices May Fall

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Borrowing, CEO, CFO, Invest, Investing, Loss, Lulemon, news, Options, portfolio, Profit, Sale, Shorting, Stocks, Think, Twitter, win, Yoga

This week I will be covering how to short a stock and what this entails.

Shorting-

The first way to take advantage of a possible price drop is to short the stock. This is the opposite of buying a stock (what you would do when you think the price will increase). When you short a stock, what you are technically doing is selling a stock that you do not own. The point of this is that you sell the stock when it is at its current market price (or at a limit price that you set) and then buy the stock at a lower price. By doing this, you are able to make a profit on the difference. You may be thinking: “how exactly can an investor sell shares that they do not have? It doesn’t make sense.” How this works is, when you short a stock you are borrowing the stock to sell from a broker. Your broker lends you the stocks to sell and then you owe him these stocks. The stocks are a promise to be delivered and when you buy the stocks at a later time, you even out the borrowing. You do not actually get the money that you sell the stocks for as you still have to buy the stocks back as they were never yours to sell in the first place. They were borrowed and you owe your broker however many stocks you borrowed and must buy them at a later time. If the price lowers like you expected, you can buy them back for a lower price and get to keep the difference as a credit to your account between the price you sold for and the price you paid to buy back. If the stocks go up in price, you may end up buying back at a higher price than you originally sold them at. In this case, you have a loss and the money will be subtracted from your account.  When the investor buys the stocks it is called “closing” the position as he/she no longer owes shares.

Lulemon Example                                                                                                                                                              

For our example, we will use Lulemon Athletica Inc. This morning, Lulemon lowered their outlook and expectations for the fiscal year and quarters, and also announced their CFO was leaving. This is never good news and because of these reductions, shareholders jumped off ship and the stock plummeted. It is down almost 15 percent today. Now if I had expected that Lulemon was overpriced I may have decided to short the stock.  Let’s assume that my timing was near perfect and I decided to short the stock yesterday night before closing when the stock was priced at $44.30. If I shorted 1000 shares of Lulemon, I would have been paid $44,300 for the shares. However, keep in mind that this is not an actual payment to you as the shares are purely borrowed.  After seeing the massive plunge in price today, I would likely decide to buy the stocks back as I feel that their price is low enough that I would see a great profit and want to take advantage before the stock possibly increases in price again. Right now, the price is around $37.40. I would close my open position with my broker by purchasing 100 shares of this stock at this price. My position is now closed and I now own zero shares of the stock. Previously I owned negative 1000 shares of the stock (borrowed) and after buying 1000 shares to close out the position I sit at zero shares. So what is my profit or loss? My profit (because the stock decreased) is the difference between the price I sold it at and the price I bought it at multiplied by the amount of shares. In this case my profit comes out to ((44.30-37.40)*1000) $6900. This is a good example of how to use shorting to make a profit off of bad stock news.

Twitter Example-                                                                                                                                                                   

Unfortunately for us, we may think a stock is going to decrease in price but it may not end up happening. In this case, an investor could face a potential loss from shorting a stock.  In the same way that a stock decreasing in value is bad if you bought a stock, a stock increasing in value is bad if you shorted one.  To show the potential dangers of shorting a stock I will use Twitter as an example. The COO of twitter resigned this morning following disagreements with the CEO. The resignation of any major well liked executive can often have a negative impact on a company and because of this it is possible that an investor would try to short Twitter and gain a small gain off of this stock news.  The investor may have borrowed and sold 1000 shares of this stock at the opening of the market this morning at a price of $35.06 expecting the stock to drop after this news broke early this morning.  However, the stock price has actually risen nearly 4 percent already today.  Fearing an even greater spike in price, the investor may have bought back the stocks at 12.45 pm at a price of $36.77. After closing out his position, the investor has accumulated a loss of ((36.77-35.06)*1000) $1,710. This not only proves that stock can move unexpectedly but also shows the dangers of shorting a stock.

Conclusion-

Shorting stocks is an interesting option in the market and like any other options has its benefits and dangers. If you know how to short stocks and have a keen eye for the market as well as a bit of luck, you could potentially make some profit using this tool. In future posts I will also go over some other ways that investors could potentially incorporate shorting stocks into their portfolios.

Stocks: An Introduction to Investing

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Basic, Beginners, Decisions, Dividend, Education, Gain, Income, Invest, Investment Tools, Learn, Long-term, Loss, Market, Profit, PV, Qualitative, Quantitative, Shareholder, Stocks, Voting

I will continue to do posts about different kinds of options involving my past stock picks and will continue to inform and talk about different kinds of market tools. However, I thought that it would be beneficial to add a different segment where I talk about some of the basics of investing and options in order to further educate my readers who are less knowledgeable of the world of finance and the stock market.

This week I will talk about the most basic tool of the stock market: Stocks themselves

Stocks-

Stocks are perhaps the simplest tool for investing.  When an investor purchases a stock, they are in theory, purchasing a part of the company. For example, if I was to purchase one share of Apple Inc., I am now a shareholder of the company. I own part of the company (even if my ownership percentage is absolutely minuscule). In owning stocks of the company I now have the right to vote on some smaller things within the company, though with only one share of a giant company my vote likely would have no impact whatsoever.  I also have the right to obtain any dividends that the company gives out. If the company has a 1 percent dividend on their $600 stock and their next dividend payout was November 15, then I would receive a $6 payment on November 15 (if I hold the stock for that long).

So how do I buy a stock?

Investors can create an account with an online stock brokerage dealer such as E-trade or TD-Ameritrade. They can deposit money and then go on and buy shares. Shares move down and up in price based on consumer conceptions about the stock, stock news, and macroeconomic events. When purchasing a share, you buy the amount of shares that you want at the current market price or can set limit purchases or use other buying tools that are available to investors. If you are to buy at the market price, the stock will be bought at whatever price the stock is set at when you press purchase (more or less depending on bid and ask prices). For example, if I wanted to buy 100 shares of Ford at the market price which is $16.68, it would cost me 1668 dollars. Similarly if I wanted to buy 200 shares of Boeing at its current market price of $136.82 it would cost me $27,364 (200 times 136.82). If I thought the price of Boeing was too high and I would only buy it if it lowered to $135, I could set a limit buy order on it. By setting a limit buy order, I have set an order to buy the stock when (if) it decreases to my set limit price. Thus if Boeing goes down to $135 in two days, the order would be executed at that time that it hits that price, and the purchase of 200 shares would cost me only $27,000. By using a limit buy order, an investor can make sure that they are purchasing the stock at price they are comfortable with.

So why would I buy a certain stock?

The question that all investors would like to have answered: Why should I buy this stock? There are a multitude of different reasons to buy a stock and which ones are chosen differ from person to person.  People look at stocks and buy because they think they are good companies who have great growth potential. Others buy just because they like the companies or have a gut feeling.  Some use qualitative and quantitative statistics to determine if a stock is worthy of a purchase. Clearly when somebody buys a stock, they want the price to go up.  Thus people want to find stocks that have growth potential or are undervalued and will likely go up in price.  There are many statistics that are important when investing such as price to book ratios and strong financial statements and balance sheets. However, what each person looks for is different and everyone has a different idea of what to look for in a strong stock. When investing it is useful to first establish what you want in a stock and then find stocks based on those guidelines.

So what happens after I purchase a stock?

In long term investing, investors remain patient and let the stock stand in their portfolio (collection of stocks) for a long period of time. However, this is not always easy if your stock falls and decreases in value and people are often tempted to sell quick and either gain a quick profit or sell before massive losses occur. This can sometimes be the right move, but it can also sometimes be a terrible mistake. Personally I purchased a large quantity of a certain stock recently at a price of below $.50. The stock saw fantastic news and rose quickly to a price of over $2. The stock then dropped to $1.78 and I panicked and sold it so that I could realize my gain before it dropped further. If the stock would have dropped further I would have made a great choice. However, the stock continued to climb and ended up at a high of nearly $5 later in the week.  That is the world of investing. As investors we do not know what stocks are going to do. We can make educated guesses but we will never know for sure.  You can sell or you can continue to keep your stock in your portfolio and hope it keeps going up.  As investors we need to just make decisions based on guesses and predictions about what the stocks are going to do.

Impact of a price change on a stock-

Lastly I will talk about what investors want to hear about the most: Money. When a price increases by $1 it has the exact opposite effect that a $1 decrease would have. For example, in my previous Ford example, the price could increase $1 to 17.68. If it does this, I would gain the increase multiplied by my amount of shares. In this situation, the value of my shares would now be $1768 as compared to its previous amount of $1668. Similarly, if the price decreased by a dollar the value of my stocks would be $1568. I could sell it at $1768 when it goes up by a dollar and see a profit of $100 (not including transaction costs). However, the stock could keep going up in price. Your call investor!

Investing in stocks is a dangerous game to play if you do not know what you are doing, but there is also a lot of money to be gained if you are smart and play the market well. There are people who have made millions and billions of dollars in the stock market. However, there are also those who have lost millions. The stock market is an interesting world and holds many opportunities but you have to know how to play it. Hopefully this piece has helped those who do not understand the market or who are new to it to understand better.

To end this introduction to stocks and investing in them, I have included two graphs of popular stocks that show how their prices can change. The first is a graph of the stock price of General Electric over the last year. It also shows the daily trading volume of the stock.

The other is a graph showing the volatility of Twitter on their first day as a publicly traded stock in November of 2013.  This graph does well to show how much a stock can potentially move in one day (though IPO days do tend to me more volatile).

Covered Calls and Protective Puts: Generating Income and Preventing Large Losses

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Biosciences, Breakeven, Call, Covered Call, Cytokinetics, Gain, Income, Invest, Investing, Loss, Options, Premium, Price, Profit, Protective Put, Put, Risk, Stock

Options Week 2

Continuing with options this week I will be showing how to use a covered call and how to use a protective put. These are two options that combine one option with owning the stock. They are very conservative options and can be used in correlation with a long term investment in a stock.

Covered Call-

I will be performing a covered call on Neurocrine Biosciences Inc. Performing a covered call involves selling a call on a stock that you also own shares of. In doing this, investors are able to add profit to their portfolio by means of a premium.  In doing this they lessen their potential loss if the stock price is to go down. However, they also limit their maximum gain as every increase in stock price will gain money from the ownership of the stock but will lose money based on the sale of the call.  Because of this, covered calls are optimal to do short term when you believe that the stock price will stay semi stagnant and do not expect large increases in the price. I will be performing the covered call on Neurocrine because although it is a stock that I believe has room for growth, I do not see it growing largely within the next couple of months.

For this example, we will assume I own 1000 shares of Neurocrine and say that it is at a current stock price of $14.00 (in reality is around $13.91). To complete the covered call, I will sell 10 contracts (1000 calls) of an August 2014 call at the price of $14 for $1.60.  This gives me a $1600 dollar premium paid to me right now.  Based on this situation I can then perform an analysis to see how I would fare based on the price at the expiration date.  This lowers my maximum possible loss if the stock were to hit $0 to $12400 rather than $14000. My break-even point would be $12.40 meaning the stock could decrease by $1.60 in price and I would still see a profit.  One drawback to this however, is that if the stock were to increase to $17 I would only realize a gain of $1600 (the premium) as compared to having a gain of $3000 if I had just owned the stock.  If the stock is likely to remain stagnant, or there is a possibility that the stock could decrease in price, a covered call is a smart and conservative option.

Protective Put –

A protective put has the opposite effect of a covered call. A protective put is buying a put when you also own shares of the stocks. By doing so, the investor has the opportunity to “protect” themselves from a large loss while also keeping the opportunity to profit if the stock goes up. In some ways it is insurance on your portfolio or stock.  This decreases the risk to only the premium you pay.  You would perform a protective put when you believe that the price will rise, but would like to protect yourself in case it is to fall.

I will be performing a protective put on Cytokinetics Incorporated. The company has the potential to be very successful and even has a price target of $10 for the year. However, their price depends massively on their results and if they have failures in their drug trials, they could decline in price greatly. Because of this, I would like to decrease my risk and will do so from the usage of a protective put.  For this situation, we will say I own 1000 shares of the stock at a price of $5 (4.71 in reality) To protect myself I will buy 10 contracts of a July Put (1000 puts) at $5 for $0.6. These puts will cost me a premium of $600. This makes my largest possible loss $600 rather than the potential $5000 I could lose without the protective put. It also does not limit my maximum gain as the gains would be exactly the same with the $600 dollar premium subtracted from them. If the price were to hit the price target of $10, I would gain a profit of $4400 compared to $5000. However, if the price were to drop dramatically due to negative drug news, I would be protected from massive loss.  A protective put is very useful to protect yourself from a drop in the stock price.

Options: Butterfly Spread and Bull Call Spread

Tags

Butterfly, Creative, Invest, Investing, Market, Money, New, Options, Profit, Risk, Stocks, Wrestling

New Changes-

I have decided to add a new more educational piece to my blog. On occasion, I will discuss different terms of the market.

Options Week- This week I will be doing something different and will be giving an example of options that could be performed on two of the stocks that I have reviewed.  I will be discussing how to use a bull spread with World Wrestling Entertainment as an example and how to perform a butterfly spread using Merrimack Pharmaceuticals as an example.

WWE-

On WWE I will be performing a bull call spread. A bull call spread is useful when you expect the price to go up a little, but not a lot.

The first stock that I will be looking at stock options on is World Wrestling Entertainment. When I reviewed this stock last week, I talked about how I believed it was very undervalued and how its target price is way above its current stock price. Because I believe the stock price will go up and would like to take advantage of this, I will first look at buying a call. I will be looking at October 2014 calls in this case.  The call I have chosen to look at is a call at a strike price of $12.50 with a premium of $1.21. In purchasing 1000 of this call, the Break Even Point would be $13.71 which is well under the target price of $23.19. Every dollar increase after the BEP would result in an increase of $1000. If WWE was to reach the target price of $23.19 the profit would be $9480. This seems like a terrific option to take advantage of and could gain huge benefits.

However if the stock were to not reach the strike price, the investor would lose the initial $1210 spent as a premium.  If you believe strongly in the stock this may be a risk you would take, but if you want to decrease risk, you could do so by selling a call at a higher price. This is called a bull call spread and would decrease risk.  The call I would choose to sell has a strike price of $14 and a premium of $.89. By combing these two options you can decrease the potential loss. Doing so however would decrease the potential gain as well. By combing, the maximum loss would be $320 if the price dropped to zero (highly unlikely). If the price was to rise above $14 the profit would be set at $1180. This is a much safer option and would also have a lower break even point at $12.82. The following is the graph for a bull call spread. The blue lines represent the calls whereas the red line represents profit.

Merrimack Pharmaceuticals-

I will be showing the reader how to use a butterfly spread in this situation and will do so on Merrimack Pharmaceuticals. A butterfly spread involves four contracts and three strike prices. The investor buys a contract (call or put, doesn’t matter which) at the lowest strike price and the highest strike price, and then sells two contracts at the middle strike price. Butterfly spreads tend to have very minimal risk and are useful when you do not expect the price to deviate much from its current position.

Merrimack is currently priced at around $8.00. Because it is a pharmaceutical company and will likely not have any drugs come out in the near future, its stock price will likely not rise that much. Because of this, a short term butterfly spread could lead to a small profit.

In this situation, my three strike prices for Merrimack for July calls are at $6, $8, and $10. The premiums respectively are $1.60, $.83 and $.20. Because of this, my initial cash flow after buying 1000 calls at the $6 strike price, 1000 calls at the $10 strike price and selling 2000 calls at the $8 strike price is -$340. This also happens to be the maximum loss the investor can have as they due to their butterfly spread; they cannot lose more than the initial cash flow from the premiums. In this case, the maximum profit would occur at the second strike price and current price of $8 where the investor would gain a $1660 profit. The two break even points in this situation would be $9.66 and $6.34. Any price in-between these two would yield a profit. If you are an investor who after looking at Merrimack Pharmaceuticals or any other company, decides they will likely stay around their current price, then performing a butterfly spread could be a smart option for you.  The blue lines represent the calls whereas the red line represents profit. Remember that the blue line in the middle is steeper as it is 2x the calls of the other blue lines.

World Wrestling Entertainment: Revenues Reviewed

Tags

Annuities, Broadcast, Hulk Hogan, Interesting, Investing, Markets, McMahon, NBCUniversal, PPV, Price, Research, Revenues, Stock, Subscription, Television, Trading, Undervalued, Wrestling

Company Description-

World Wrestling Entertainment (WWE) is the leader in global-sports entertainment. It is a massive integrated media organization that focuses primarily on wrestling and also sees major revenue streams coming in from sales of memorabilia, film, TV, and other forms of media. For those who believe that wrestling is real, I am sorry to say it is not. It is completely scripted and is technically entertainment as compared to an actual sport. However, real injuries do occur based on the types of things that are attempted. WWE is committed to family friendly entertainment on its television programming, pay-per-view, digital media and publishing platforms. It is broadcast in more than 150 countries and in more than 30 different languages as well.  Many do not realize that this company is a publicly traded company and has been so since October of 1999. The stock price of the company has reached as high as $32 dollars and is currently at $11.27 (as of 5/18/14). This company has reached over 600 million households around the world with their broadcasts and is definitely a stock worth some consideration.

Potential and Problems-

The company, run by billionaire and former wrestler Vince McMahon has seen increasing revenues for some time and expects to increase this trend in the future. That being said, the company struggled in 2013 and despite an increase in revenues, saw net income fall drastically. This was due in part to the fact that they had to take a 12 million dollar impairment charge on their WWE Studios business as well as a continued decline in revenues from the consumer products segment of the business. Although their slip in net income was large, the company still has potential to grow and increase their business, revenues, and income. It was announced in late February that superstar and fan favorite Hulk Hogan will be returning to the network in hosting roles, which should help to increase viewership as people turn on to see “Hulkmania” once again. WWE is also replacing its pay per view system with a subscription annuity revenue stream, bringing it into play with companies such as Netflix and Amazon Prime and giving WWE the ability to cater to new markets. The company has said that it will need to attract about 1.4 million subscribers to its subscription based revenue stream in order to make up for cannibalization of pay per view revenues. This may not happen within the year and the company could see some loss of revenue because of this, but from a long term standpoint this is a smart and strategic move for the companyWWE also launched the first 24-hour per day OTT serialized-sports network in the world! This is currently only available in the US and has already garnered over 700,000 subscribers, but there are plans to expand into other countries within the near future.  However, the biggest impact on WWE’s stock is likely that of its new deal with NBCUniversal. A new deal was announced on Friday that ensures that revenue from NBC will increase 50%! That is a massive increase in revenue and will help to both bring WWE’s revenues and net incomes higher. Surprisingly however, the report of this deal led to a massive decline in stock price (from $19.93 at close on Thursday down to the current price of $11.27) due to previous reports that the deal with NBC would triple or double revenue as opposed to just increasing it by 50%.

Stock Analysis-

Frankly, I do not like wrestling and think it is pointless to watch. However, there are millions who feel differently from me and continue to watch WWE and its subsidiaries. As a stock, I believe this company is a very interesting option and I currently rate it a buy. After analyzing the future of the company and looking over their financial statements, cash flows, and balance sheet I believe that they have the potential to expand and continue to succeed within both the domestic market and foreign markets. The biggest reason I like this stock at the moment is because of the price. It is very underpriced and the massive drop in price over the last few days has led to this. This reaction is not what people with a stake in the company or the company itself wanted, but for investors who were keeping an eye on the stock but hadn’t quite got around to investing, the drop in price is a gift.  At the current price of $11.27 the stock is seriously underpriced and is bound to go up. It may not rise in the near future, but one thing is for certain: this stock will rise again. Analyst estimates are much higher than the current price even with adjustments. Benchmark analyst Mike Hickey downgraded the rating on the stock from buy to hold after the massive drop on Friday and dropped his estimate from $29.12 to $19.96. This is a massive drop in an estimate, but his estimate is still nearly $9 above the current price. After Hickeys downgrade, 5 of the 8 analysts on Bloomberg rate the stock a buy, with 2 (1 being Hickey) rating a hold and one rating a sell. The average price estimate is about $25.50, easily double of the current stock price. There may be some adjustments based on the recent drop in price and deal with NBCUniversal, but they will surely be higher than the current price by a considerable amount. This overreaction to the deal has given investors a great opportunity to buy. Even if you are like me and have no interest in wrestling, this stock has high potential and is a definite buy to consider.

 

Neurocrine Biosciences: Treating Women Soon

Tags

Biopharmaceutical, Elagolix, Endocrine, Endometriosis, Innovation, Investments, Opportunity, Research, Stocks, Uterine Fibroids

Company Description-

Based in San Diego, Neurocrine Biosciences (NBIX) is a biopharmaceutical company that discovers and develops innovative and life-changing pharmaceuticals for diseases with unmet medical needs or solutions. They utilize a very heavy research and development platform while focusing on neurological and endocrine based diseases and disorders. The company works hard to create new drugs and therapies, screen these therapies and then advance them through preclinicals and trials in order to pass along their products to consumers and hopefully better the lives of patients. Their overall goals are to improve the lives of patients suffering from diseases with unmet clinical needs and to use innovation to create cures for said diseases.

Drugs and Pipeline-

Neurocrine currently has three major drugs in the pipeline. They are Elagolix (a Gonadotropin-Releasing Hormone (GnRH) Antagonist), NBI-98854 (a Vesicular Monoamine Transporter 2 Inhibitor), and NBI-77860. Elagolix is a drug that can potentially be used for the treatment of uterine diseases whereas NIB-98854 AND NBI-77860 are drugs that are focused on diseases of the central nervous system. Elagolix has shown the most promise so far and is now in phase three of trials.

Elagolix –

Elagolix is a drug that stimulates the secretion of the pituitary hormones that are responsible for sex steroid production and normal reproductive function. This is clinically useful in treating diseases such as endometriosis and uterine fibroids as it allows for hormone suppression. It can thus lessen the pain and symptoms of Menopause and hormone-dependent diseases within the body.  Uterine fibroids are benign tumors that form in the walls of the uterus. Although most women do not feel symptoms, uterine fibroids can cause pelvic pain, reproductive problems, and severe bleeding that can lead to anemia. This can eventually lead to the woman needing a hysterectomy as well. Elagolix has shown its potential use for diseases such as endometriosis and uterine fibroids in phases one and two and has now progressed to phase three testing. However, this drug promises even more than this as it could also potentially be utilized in other women’s diseases involving the uterus and uterine system.

Stock Analysis-

When considering and evaluating the stock value of Neurocrine Biosciences, we must look at what they potentially have to offer. They have shown a lot of promise with their Elagolix drug and if they are able to pass this drug through phase three trials then their stock will skyrocket. However, with any kind of therapeutic drug there is no guarantee that success will occur and they still have quite a way to go. Neurocrine Biosciences is currently priced at $13.84 compared to their price of around $19 in mid-January. Neurocrine saw their high price in 2006 but the stock plummeted 62% after the FDA denied approval for a drug they had created to treat insomnia. They were forced to lay off a large amount of people and struggled mightily until 2010 when it was announced that Elagolix had achieved its main and secondary goals in its study. If they are to find success with Elagolix in the phase three stage and are able to move the drug to market, they will reap tremendous gains. The company has seen a large decrease in net revenue this year as they turn their focus to Elagolix. However, their current ratio has increased dramatically in recent years.  Analysts expect the stock to find great success with the impending success of Elagolix and have pushed a one year price target of around $20 on average (Yahoo Finance).  Based on analyst estimates and the potential of this company, I rate the stock a buy. They may not see gains in the near future, but once Elagolix is able to reach the market, the stock will rise substantially.