[Options] Playing a Risky Reversal

Sean McLaughlin
October 26, 2022

We continue to be handcuffed by earnings season. Some of the best setups we like right now are in stocks slated to announce earnings over the next week or two. As an options trader, I don't like to position ahead of imminent earnings announcements. That is tough binary risk to control.

Today's trade has earnings coming up in a little over a month from now, so that'll have to do. At least it gives us some time to build a little cushion. Because if we're wrong in this trade, it's likely we'll find out pretty quickly over the next two weeks.

During our Analyst meeting this morning, JC really like this setup in Sociedad Quimica y Minera $SQM:

In short, he feels that if we see any more weakness in the dollar, then lithium plays rip higher from here.

So we're going to get aggressive with a modified Bullish Risk Reversal trade in $SQM that engages in lithium and more.

Here's the Play:

We like a bullish unbalanced Risk Reversal in $SQM January options. We'll be selling two January 80 puts for every one January 105 call we purchase. We can put this trade on now for an approximately $1.00 net credit.

Here's how the PnL graph for this type of trade looks:

We're selling more puts than the number of calls we're purchasing so that we can have a net credit in this trade on Day 1. I like to sell puts to completely finance the purchase of the calls. But we needed to buy the more expensive 105 call strike to get the juice we're looking for in any upside move back to highs for $SQM.

Due to the naked puts, brokerages will require approximately $1200 per short put we have in this position. So, in our case, it'll require $2400 since we're selling two.

Our risk management in this trade is as follows: Any $SQM close below $80 per share, which corresponds with both the intraday low in October as well as the strike of our short puts, is our signal to exit. We're betting that the recent low holds. If it does not, we're not going to fight it. We'll take the loss and move on.

Meanwhile, as long as $SQM stays above $80 share, then we'll continue holding into expiration. The worst case scenario would be that both options expire worthless and we keep the $1.00 credit we collect today. The best case is $SQM rips and our 105 calls are in-the-money and it's pure unlimited profit from there.

JC and I will be live on Twitter later this afternoon (around 2pm ET) to discuss JCs thoughts on this position a little deeper. Join us!

If you have any questions on this trade, please send them here.

ASO subscribers who missed last week’s live video Jam Session where we reviewed activity in our options portfolio from the past week can catch it here.

~ @chicagosean

P.S. We do trades like this regularly. If you'd like to leverage Best-in-Class technical analysis into smarter directional options trades, try out All Star Options Risk Free! Or give us a call to learn more: 323-421-7991.

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