[Options] Looking for a Freeport in the Storm
Right now, implied volatility in FCX options is nicely elevated:
I am mindful that earnings for $FCX will be released in two weeks. Pending earnings events is often a volatility driver, but it feels to me that right now its more the fear from recent price slides that has buyers bidding up the cost of puts here.
So we're going to leverage the put buyers fear to help us pay for a bullish call position.
The nice thing here is, as JC said: "We're likely gonna know if we're wrong right away. So we either get out quickly -- no biggie -- or we've got a winner on our hands."
So let's do this!
Here's the Play:
We're entering a bullish Risk Reversal in $FCX at the 28 and 36 strikes in November options for an approximately 20 cents credit. This means I'll be naked short the Nov 28 puts and long an equal amount of 36 calls.
Here's how the risk graph lays out:
I'm not concerned about getting a precise credit here. I'm not in it for the credit. But I do want to make sure the cost of the calls is covered by the credit from the naked puts.
Because this position requires margin and contains theoretically unlimited risk, I'll be sizing the position small.
Usually with Risk Reversals, I'll look to sell some of the long calls in an effort to use that credit to completely close the short puts as the position goes my way. But in this case, I'm going to let the short puts ride and instead -- I'm going to look to take profits if $FCX trades above the $39 level. If/when we get above $39 per share, I'll sell to close half of my calls and buy to close half of my puts, booking some profits and I'll let the rest ride into November. Once in November, if $FCX is under our 36 calls strike, then I'll close the rest of the position down, win or lose. If $FCX is above 36 in November, then I'll continue to hold the spread for as long as $FCX stays above near-term support (3-5 day low).
On the downside, like JC said, we'll likely know if we're wrong pretty quick -- and that's great! If $FCX can't hold the $30 level, that's our signal to get out. Any close below $30 means we'll exit the trade near the open on the next trading day.
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