[Options] Knowing When To Pick Your Spot For A Bounce

Sean McLaughlin
August 29, 2018

When a stock has the potential to double from here, you have to get aggressively long. This is especially the case when there is a clearly defined risk management level. This often happens when a stock has been beaten to a pulp to the lowest prices in years. Which brings us to today's poster child for disgruntled shareholders: General Electric.

Is there a more downtrodden stock out there right now than shares of General Electric $GE?

A quick google search of headlines is downright depressing if you're a $GE Long:

All of those headlines make for great clickbait -- especially for nervous longs -- but all of it is complete noise. And none of it will make you money. We at All Star Charts focus squarely on price and volume which form the basic building blocks of all technical analysis. And we'll occasionally sprinkle in a little investor psychology, especially if we spent the night at a Holiday Inn Express recently (if you don't get the joke, nevermind...).

GE feels like it's at one of those psychologically significant inflection points. The entire street is bearish on the name, bottom fishers have gotten steam-rolled again and again, and price action suggest long-term investors have thrown in the towel.

But wait... what's that we see from a technical standpoint, hiding in plain sight?

Is that a bullish RSI divergence developing on a weekly chart of $GE? Here's the ASC take on $GE in a recent piece which highlighted $GE as a possible turnaround play:

The new 9-year lows in price last week with a potential bullish divergence developing could be the catalyst to send this thing ripping. Not only did momentum diverge positively from the prior low, RSI did not even reach oversold conditions, which is consistent with an environment where prices are rising. A double from here in $GE is not out of the question.

Well, picking bottoms in flushed-out stocks isn't usually my idea of a good time, but it worked out great for us in DeutscheBank $DB a month ago, so I'm willing to step into the ring again with a couple of trade ideas with a clearly defined risk management level.

Here's how we're going to get long $GE for a bounce with options:

I've got two strategies for consideration, depending on how risk tolerant we're feeling -- one play with simple straight calls and another more aggressive Risk Reversal idea.

  1. If we're feeling a little more risk adverse, then the play is to be a buyer of long calls. To me, the December 14 strike calls currently offered at 32 cents have the right mix of low cost to participate, coupled with a 28 delta that will give us a nice bang for the buck if this stock does indeed bounce significantly higher from here as we are thinking it might. As always with long calls, I'll be looking to close half of my position when I can sell it for double what I paid. This removes all of my risk from the trade and gives me a free ride on the rest. If $GE never quite catches a bid, I'll prepare in advance for this outcome by making sure I've sized my position small enough so that a highly likely 100% loss represents a dollar loss to my portfolio that is well within the range of acceptable. With 114 days until December expiration, I like our odds of having a chance to make some money with this play.
  2. If we're feeling a little more aggressive and either confident that the low is in, or in holding long stock, then we may consider coupling the long December 14 call with a short December 12 put, which is currently bid at 42 cents. This would get you long a Bullish Risk Reversal at a net credit of about 10 cents. As long as $GE doesn't expire below $12 (which would represent a new 9-year low), then we'll make money on this trade. Here's how the risk graph for this position would look:$12 would be the key risk management level we'll keep an eye on. If $GE closes below $12 (I'm not too concerned about an intraday dip), then I'll close this trade and look for another setup. I have no interest in riding a loss any further than that. If, on the other hand, $GE cruises higher, then we'll have all the patience in the world to sit in our profits and ride this thing as far into December as we can (and as long as the technicals don't give us a compelling reason to take profits). If $GE is anywhere near $14 (the strike price of our calls) once we get into the month of December, we'll look to close the position as soon as feasible as theta and/or gamma risk will start to become annoyances while we get close to expiration.

The naked long call play (option #1) is pretty straight forward, but if you have any questions on that or how to play this Risk Reversal (#2), feel free to email me here.

~ @chicagosean

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