Trade Idea of the Week 10-11-19: BBBY
Is a 5% yield for ECA too good to be true?
5% yields usually mean higher risk
ECA has a 5% yield going out to November expiration. I do a show a couple times a week for the Options Insider Radio Network and there is a segment called the Odd Block. Usually there are interesting trades and it highlights areas I might not normally look at. ECA is just off of my radar as a Natural Gas producer that has managed to stick around and still pay a dividend from $2.25 per BTU gas. I think this buy write is interesting.
How to estimate a 5% call yield?
There was huge volume on the Nov15 $4 strike of around 33000 options. My sense is that the paper direction was buy since the IV rose around 7 pts to 69% by the end of the day. To find out what the yield is we need to do a little arithmetic. The active price was .50 for the calls so 4.50 net for the $4 strike. Subtract the stock price, $4.28, and there is .22 left over or 4.5% yield to Nov. Ok, not quite 5% but the stock was up intra- day. .22 is not much but the name is only $4.0 and trading at multi-year lows.
Why is paper paying .50 for the calls
The question is why is paper paying .50 or over 10% of the underlying value for such a short period of time? Takeover or other corporate action or maybe even a synthetic put? At $4 the short/synthetic put concept does not make a lot sense. While I realized we produce more Nat Gas then we can consume now, a buy write approach to names at this level might work. The stated book value for ECA is 7.19. We got that going for us. I will go for a taste on this tomorrow and see where it goes.
Disclosure- Long Nat Gas and Nat Gas stocks
Sometimes a SPY option does not decay
SPY option time decay is not guaranteed
SPY option decay is taken as a given most of the time. If you are wondering about what option time decay is, it is simply options will lose value over time as they get closer to expiration. Think of it as less time to expiration means a lower option premium. The catch is that all inputs have to remain constant for the option to wither away like heat from a coffee mug. If the only thing that changes is time, the options decline in value and this is a big factor in selling options. The sun will rise the next day and the option disappears a little bit.
Time and Volatility mess up SPY option decay
Liquidity providers like to buy options as cheap as they can. They can move prices around by adjusting the volatility assumption in their trade machine models. If they want options prices to stop decaying, they simply move up the volatility until it generates the price they want. My Monday blog was put into action on Tuesday morning. Part of the reason was that option volatility was picking up a bid when really it should have been decaying into Oct 10th under normal circumstances. I added a pair trade to the Vol Newsletter buying OTM SPY Oct18 296 calls and VXX Oct18 25.5 calls for a 2.20 package on Tuesday morning early. The idea was something might happen but the decay on next week’s options should be slower than normal because of the trade talks.
The VXX and SPY options did not decay overnight
The screenshots below show the opening prices of the package this morning. The options had higher prices than 24 hrs. before. Voila reverse time decay! The two big moves in SPY and VXX yesterday and today afforded a quick 20% gain and exit by mid-morning with very low risk.
VXX Oct18 25.5 calls for 1.25 or up .05 from previous day source Cboe Livevol
SPY Oct18 196 calls for 1.10 or up .10 from previous day source Cboe LiveVol
Sell SPY options when they are most likely to decay
SPY options, or just about any equity or index option, have optimal decay periods depending on the state of volatility and what is on the calendar. Learning what those periods are is just education and practice. For the education part, try our Platinum Course. It restarts next week.
Disclosure: VIX, SPY and VXX positions