by Dan Passarelli | April 4, 2011 5:00 am
(Editor’s Note: At the time of this posting the ramifications of a court case involving TiVo weren’t clear. Since then, there have been reports a decision may soon be made in the case that could seriously impact the stock price of TIVO.)
TiVo Inc. (NASDAQ: TIVO[1]) may very well have seen its best days. This one-time pioneer has found itself not adapting to the new world it helped to create. Last we heard, they are offering lower guidance to future earnings. And its chart? Not promising.
But when stocks appear to give you lemons, the best options trading[2] investors say screw the lemons and find a way to make money off it! In the case of TIVO, there is a classic volatility-selling set up being gifted to clever traders.
The play is an iron condor[3] — but not your typical iron condor. Usually traders who trade iron condors are looking for really boring stocks that have cheap options (in terms of implied volatility), reflecting the unlikelihood for future volatility. This TIVO trade, however, has a different philosophy. It’s not a boring, low-volatility stock. It’s an interesting stock that has, in the past, seen some volatility. But, here’s the premise: The option prices (in terms of implied volatility) are way too expensive given the likelihood for future volatility. The options play? Sell, Mortimer, sell!
An iron condor is a way to sell option premium with protection. The best way to look at it — in this case — is as a short strangle, with a long strangle that has wider strikes existing for protection. Sounds convoluted but let’s look at the trade specifics.
TIVO Iron Condor
Sell the April 8-10 strangle (or sell the TIVO April 8 Puts and April 10 Calls) and at the same time buy the April 6-12 strangle (or buy the TIVO April 6Puts and the April 12 Calls). This can be done as one single four-legged trade. The four-legged trade should net a total credit of 50 cents or better.
Check with your broker whether you can make Iron Condor trades in your account. Some brokers limit certain trading strategies. In addition, brokers may charge higher fees for four-sided trades.
The trade works if over the next 15 days, TIVO remains between $8 and $10 a share — a wide range for just two weeks, especially considering price action over the past month. If TIVO remains within this range, the trade nets a 50-cent profit (the total premium initially received). If, however, the unlikely occurs and TIVO busts out of this range, the trade ends up a loser. The maximum possible loss is $1.50, which occurs if TIVO is below $6 or above $12 two weeks from now, at expiration.
The premise is that considering the money at risk — 0.50 to the possible maximum loss of 1.50 — the chances of the trade working out are great. This is a trade that has, in statistics lingo, a positive expected return. It’s the kind of trade any red-blooded option trader is tickled to find; and it is one of our Market Taker Edge options newsletter[4] trades this week.
Dan Passarelli of MarketTaker.com[5] writes the Market Taker Edge options newsletter. Dan has more than 17 years’ experience in the options industry as a market maker, Options Institute instructor and author of “Trading Option Greeks.”
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