New Amazon Idea
The recent Traders Expo in Las Vegas gave us a chance to meet with other option traders and strategist as well as an opportunity to extend a few invitations to contribute some new ideas and approaches for our subscribers.
Dan Passarelli agreed to share a bull call spread idea from his strategy newsletter.
Amazon.com Inc. (AMZN)
The trade: Buy December 250/255 Bull Call Spread (buying the December 250 call and selling the December 255 call) for 2.35 or less.
The strategy: The maximum potential profit for this trade is $2.65 (5 ? 2.35) if AMZN is trading above $255 at December expiration. The maximum loss is $2.35 (or what was paid for the spread) if AMZN is trading below $250 at December expiration. Breakeven is $252.35 at December expiration based on a cost of $2.35.
The rationale: If you look at a chart of AMZN, it’s pretty clear that the stock has moved significantly higher since it bounced off of its daily 200 simple moving average. It is currently trading right around $250, which is an area that has acted as support and resistance in the past. It looks like it is taking a temporary breather from climbing higher which stocks tend to do when approaching resistance. If the stock can hold and break that resistance area, its next area to conquer would be another resistance area in the $260 region.
There are two other interesting points about this trade idea. The implied volatility on the options is currently lower than its historical average, which tends to make buying options like a debit spread a little bit cheaper. And two, if the stock follows the same course it took in late July when it moved from around $220 to just above $260, this bull call spread will look like a real beauty. A bullish sign to tip off a strong trade entry would be if AMZN can close near Friday’s high.
Takeover File Update
MetroPCS Communications, Inc. (PCS)
Previously, we suggested both a short October 12 straddle and a long February straddle. Closing the short straddle just before the October expiration produced a .62 gain. Now marking the long February 12 straddle to market shows a .61 loss.
On the news that an analyst expects a bid from Sprint, PCS ranked number one in Friday’s positive IV Change scan. Here is what Investor’s Business Daily reported he said.
“We believe MetroPCS could receive a bid from Sprint within the next one to four weeks, likely in the $12-$13 per share range”, said Guggenheim analyst Shing Yin, in a report published Friday.
Now for the updated option data.
The current Historical Volatility is 34.79 and 32.81 using the Parkinson’s range method, with an Implied Volatility Index Mean of 57.47 up from 44.14 last week. The IV/HV ratio is 1.65 and 1.75 using the range method to calculate the HV. Friday’s put-call ratio was very bullish at .10, while the volume was 65,206 contracts traded compared to the 5-day average volume of 20,500.
We should see further a increase in implied volatility as the expected date approaches that should equal the 80 level when the Deutsche Telekom merger proposal was announced, so we want to retain our February straddle, but it needs adjusting back to delta neutral since the call is out-of-the money and the put is in-the-money. Since we originally used a one-lot straddle, we will need to make the adjustment using stock. The delta of the Feb 12 call is .3442 while the Feb 12 put is -.6548 so we will need to buy 31 shares of stock (.3442 -.6548) to be delta neutral. Then in order to offset the loss of time decay the plan is to make further weekly adjustments each .50 of price change, about one standard deviation.
The first step is to buy 31 shares of stock.
In addition, we will add the following long call spread.
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In the event the Sprint bid is announced in the next couple of weeks this should give us some upside. Just in case, use a close back below 10 as the SU (stop/unwind).
Number One High IV/HV Ratio – Binary Biotech
Celsion Corp. (CLSN)
In January, this drug development company is expected to release the results of its “Phase III HEAT Study, a multinational, double-blind, placebo-controlled, pivotal study of ThermoDox? in combination with radiofrequency ablation (RFA) for the treatment of hepatocellular carcinoma (HCC), also known as primary liver cancer.” The company claims it could be a “$1 billion therapy.”
The current Historical Volatility is 78.45 and 76.54 using the Parkinson’s range method, with an Implied Volatility Index Mean of 193.84 up from 123.28 last week. The IV/HV ratio is 2.47 and 2.53, using the range method to calculate the HV, the highest in the Friday scan. The put-call ratio was in bearish territory at 1.00, while the volume was 6,929 contracts traded compared to the 5-day average volume of 20,930.
Since the implied volatility is higher in February than January it suggests the release of the Phase III test results are more likely after the regular options expiration on January 18. Accordingly, this provides an opportunity to sell January out-of-the money put below the October support level. 
In addition, we suggest adding a February long call spread with a short put combination.
While keeping in mind high implied volatility represents potential price movement in either direction and it could continue increasing between now and the end of January, this suggestion is unusual. In the event the Jan 4 put expires as expected before the announcement a .83 credit will have been booked. Presuming the announcement disappoints and the stock closes below 3 at the February expiration, another 1.20 will be credited from the February put sale, to this the loss on the long call spread of .65 will be added for a net basis of 1.62, considerably below the 3 support level back in the summer. On the upside, a close above 10 after the announcement will result in a gain approaching 3.38, calculated by 1.35 from the long call spread and two put sales, .83 and 1.20. Since this is a binary event the only real risk management available is to limit the position size and remember the implied volatility will most likely continue rising into the late January event date, so make some allowance for subsequent trades.
The suggestions above use the closing middle price between the Friday bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
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Summary
As the equity market continues to advance, other select “risk on” assets are following although a pull back to retest the November 16 pivot low is due at any time. Once completed a further advance lasting into yearend is most likely unless derailed by negative “fiscal cliff” news from Washington D.C.