I wanted to share how we carefully managed risk around an options trade for subscribers in Explosive Options today for Herbalife that left us with profits and a risk-free trade into earnings.
On Feb 2, we bought calls on Herbalife (HLF) as the technical picture had improved. Knowing competitor WTW was due for earnings in two weeks and HLF was on tap for Feb 21 it seemed March was the best choice, so it was the March 57.5 call for 3 bucks. From the outset, the stock started moving higher – slowly.
However, our option moved faster as the implied volatility pumped up prices. On Feb 17 with a three-day weekend upon us, we decided to SELL an out of the money call, the Mar 65 strike for 1.60. This gave us a credit to offset our cost on the earlier purchase of the March 57.5 strike, lowering our overall cost to 1.40.
If we had done nothing further, we would be looking at a risk of 1.40 per contract for a potential NET reward of 6.1 (difference of the short and long call strikes less the cost of the call spread – or a 435% return on risk).
But today, knowing the earnings would be out and could be a wildcard result – we decided to ‘roll up’ the 57.5 call to the 62.5 strike. Simply put we sold the 57.5 for 6.50 and bought the 62.50 for 3.50, netting us another credit – this one being 3 bucks.
So, adding the two credits together we picked up 4.60 – completely taking out our cost and then some. We took our risk in the trade down to zero and banked a 53% profit and stayed with the trade on a tighter spread. Hence, if the stock were to drop sharply down below the long call (62.5) we STILL would have earned a 53% profit (that would be if the spread went to zero).
An elusive FREE trade with a profit kicker. Alternatively, if the stock should rise past 65 and stay up there the spread would expand and give us an even greater profit when sold. The cost being zero, anything up to 2.50 is pure profit!
Earnings are out tonight and they appear to have hit this one out of the park – again. We’ll see how it goes tomorrow of course, but for those who wonder how/why I like to play earnings, this is a great reason why. Risk management of a trade is fundamental to success in trading options.