MO - Flying on instruments

Written on April 8, 2008 by OptionsRopeaDope

In my last post on MO, I noted how stupid it was to open a trade, no matter how good the tip, if you don’t know jack about the underlying. To make a long story short, MO (Phillip Morris), which was a consistent high-margin winner for a very long time for many experienced traders, just happened (to me at least) to be splitting into two companies within a week of when I opened the trade.

Looking at the performance though (I had about a 10% loss), it just didn’t add up, so as long as my max loss wasn’t reached (it should have been.. and much more since the underlying dropped 60+%) I decided to get a better view on the trade… I still haven’t figured out exactly how the options are treated after the split (seems like it reflect the sum of the MOs and PMs stock price, but who knows.) But I have been able to study the premiums. Here they are as of today -

Short APR 70 Put   .43 (-. 2)

Long MAY 70 Put   1.13 (-.1)

Short APR 75 Call   .12 (-.75)

Long MAY 75 Call    .81 (-.88)

That’s all I have… al the delta, vega, etc readings are based on an underlying in the 20s (where MO currently is). But what the prices tell me (and the fact that I am back to break even! Who would of thought?) is that the price reflected by the options is still comfortable between 70 and 75… all the behavior is expected. There was a vol decrease (high vol in anticipation of the split) which depressed the double calendar severely. But now, theta is working in my favor, as the APR options keep losing faster than the Mays.

I’ll keep watching the instruments and ride this one out, looking to close next week for a comfortable profit unless the premiums indicate movement outside the strikes. If that happens, and it happens with some volatility increase, it should give me a 20% profit. Pretty good for starting out blind!

I noticed Trader Nate did the same trade and closed quickly… hope he didn’t do it based off my initial post. If so - Sorry dude.

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