The Beginner Options Trade For Huge Upside

| April 12, 2017 | 0 Comments

optionsFinally, an options trade that you can place with little to no prior experience that has huge upside potential. Get the detailed and easy-to-understand instructions and analysis on this trade from Jay Soloff, a former floor trader with decades of experience.

Options Can Provide Huge Upside For Time Warner Bulls

Time WarnerThe death of cable TV may be greatly exaggerated, or at least one big trader believes. A huge trade in Time Warner (NYSE: TWX) suggests the massive cable and entertainment company has plenty of upside in the coming months.

Before I get to the trade, let’s take a step back and look at Time Warner. The $75 billion company makes most of its money from cable TV, although its movie production business is also a big contributor. Nevertheless, it’s the Turner and Home Box Office segments of the company that bring in about 60% of revenues.

Now, you’ve probably heard that cable is in big trouble because of Netflix (NASDAQ: NFLX) and other streaming video services. Perhaps cable TV providers, the companies actually delivering the video to your house, are in trouble in the long-run. However, cable TV production companies, like TWX, still have plenty to offer.

Think about it, it’s not like HBO and CNN are going away (both owned by Time Warner), they’re just going to be offered through different formats. For instance, you can already purchase HBO separately (HBO NOW) and stream it to your phone, tablet, or computer.

Eventually, most or all cable stations will be offered in bundles or as standalone menu items. Being a content provider like TWX is a great place to be in that not-too-distant future. What’s more, being a movie production company means they have a massive amount of proprietary content they can offer through their own channels. Netflix is certainly changing the game, but they aren’t necessarily destroying it.

Okay, so I’ve made the case for why Time Warner could be in good position looking ahead. Now, let’s look at the trade:

A trader purchased 5,000 October 100 calls for $3.20 per contact, with the stock around $98 per share. The breakeven point is $103.20, but the call owner has until October 21st before the options expire. Premium spent on this trade is a whopping $1.6 million, so you know this isn’t something done on a whim.

Whenever you see this kind of money spent on a trade, you can bet the trade thesis has been thoroughly vetted. After all, the $1.6 million could expire worthless in six months. Clearly, someone with access to massive resources isn’t going to take that kind of risk without a strong belief in a positive outcome.

Here’s the thing…

I don’t recommend emulating this trade unless you also have plenty of capital sitting around. $3.20 is a lot to pay for an option, even though time decay won’t start taking effect for several weeks. Still, there are cheaper ways to go about getting long TWX.

I often talk about buying vertical spreads to reduce premium costs (by selling an out-of-the-money call or put against your long option). Here’s another strategy you can use: selling a vertical spread to help finance your long option.

In this case, it would mean selling a put spread and using the credit received to lower the cost of your call purchase. So, let’s say you like the October 100 call for $3.20, but you don’t want to pay for all the premium. You could sell the 90-95 October put spread (selling the 95 strike, buying the 90 strike) and collect about $1.50 in premium. Now, your total cost for the calls drops to $1.70, and your breakeven point falls to $101.70.

Why use a put spread instead of naked puts? It’s simply a way to reduce downside risk. If the stock plunges, you are only on the hook for $3.50 per spread (5 strike spread width – $1.50 premium collected). Of course, you’re also on the hook for the call premium. Keep in mind, you’re only doing this type of trade if you have a strong bullish bias towards the stock. You wouldn’t do this if you doubt its upside.

If you think a 90-95 put spread is too risky, you can also lower the strikes and take in less premium. For example, the 85-90 put spread could bring in close to $1.00 in premium and gives you quite a bit more room to the downside. You could even reduce the cost further by turning the call into a call spread and selling a higher strike (thus lowering costs but capping the upside).

There are dozens of iterations of this trade which could work, and it all depends on your risk tolerance. The beauty of options is you can set up a trade in whatever way bests suits your individual needs. As with any trade, the key is finding the risk/reward combination that works for you.


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Category: Options Trading Strategy

About the Author ()

Jay Soloff is an options analyst with Investors Alley.