This is an out of the box trade. This trade was made on Sept 9th 2009.
It is a speculative trade and should be used sparingly - < 10 % of portfolio should be dedicated to this kind of trade.
Instead of a standard bear call which normally calls for OTM and front month short option, I used a 4 months call spread and ITM.
Application of this kind of trade is when you expect a stock which is fundamentally weak. It has also rallied and reaching a technical top.
Anytime the SC goes ITM, you will start to make money. You have to allow time for the trade to work
The trade offers good credit because it is ITM. Risk is minimal and probability of hitting the target ROI over time is high because of the fundamentals.
Fundamentals:
This is the most important reasons why I choose to place this trade. DHI is one of those companies which are deeply in debt. The company faces a huge series of debt maturities over the next nine years: $550 million in 2009, $360 million in 2010, $400 million in 2011, $300 million in 2012 and 2013, $500 million in 2014, $300 million in 2015, $400 million in 2016, and $800 million in 2017.They are selling assets to finance their debts.
It is selling off its inventory and assets at a loss to generate cash. In the last year, reductions in inventory produced about $1.5 billion in cash. It looks like nearly all of the money went to repay debt: Total liabilities fell by $1.1 billion. But the company still is owes $5 billion. Technically, it can't even make a top-line profit – it spends more to build a house than it earns selling it. So, without a sizeable appreciation of housing price, it will never repay its debt.
Over the last few months, the market has gone from de leveraging to re leveraging. So saw over the last few months, companies which were hugely in debt were doing very well. These companies includes COF, MGM and DHI. It is the belief that this re leveraging and access to credit is very short term. Very soon, once the pool of cash is dried up, these companies will come crashing down again.
Technicals:
As seen from the charts, the stock had tried to hit $14 thrice beg May, first week of August and third week of Aug. MACD was showing a negative divergence and had crossed over negative.
The market had gone up >40% since March. So any correction will bring the price easily down below 11.
Trades:
Bear call ITM
Buy Jan 10C strike 12.5 for 2.11
Sell Jan 10 C strike 11 for 2.77
Credit or Reward = 0.78
Risk: Spread – credit = 1.5-.789 = .72
10 contracts were placed.
Reward is slightly higher than risk. ROI is more than 50%
PE: Exit on 50% of maximum reward or credit of 0.36
SE: o If market really show signs of strong recovery by Dec, exit at 50% loss
o If prices remain stagnant and market shows no sign of recovery, roll the call up another 3-4 months to allow this trade to work
Status: With last Friday decline, the trade is hitting about 40% of maximum reward. I will get out when it hits 50%. When I exit, I will place a comment on this trade.
Posts
My ITM DHI call almost hit my ROI but I did not exit.
ReplyDeleteNow it has found some support because of the bullish market.
But I have time on my side. I am still making money.
I believe I will hit above my target after this earning season is over.
DHI announced results today and they narrowed lost.
ReplyDeleteBut what the market does not like is what I had outlined above - their DEBT!!
I believe DHI will continue to go down.
I hit my ROI today. It closed for .4. ROI = 51% for 2 months.
I am still bearish. I am looking to putting a bearish trade when the conditions are right.
Meanwhile, I believe the market has over reacted by bring down the price -16% this morning as I write.
It may bounce back to 11.5 near the breakaway gap. If so, I will entering a bear trade.
Stock may continue to go down. It is very negative. Market is worried whether this company can survive.
To me, there is a high possibility it will go bankrupt if there is a downturn. But now market is still bullish and thus I will wait.