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Options Update: A Diamonds Trust Short Put Spread

An options trader pockets a premium in a vertical put spread

by Joseph Hargett (jhargett@sir-inc.com) 10/30/2009 3:10 PM

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Have you found yourself feeling uncertain about the market's direction lately? Not sure the Dow Jones Industrial Average (DJIA) is going to continue higher, but you're pretty sure that a plunge isn't in the cards? No problem. By using options you can still bank a profit even in these market conditions. Take today's options activity on the Diamonds Trust, Series 1 (DIA: sentiment, chart, options) exchange-traded fund (ETF), where a trader pocketed a premium in what appears to be a short put spread. What's more, the trader keeps that premium as long as the DIA holds above a certain level by November options expiration.

For the record, the DIA is a unit investment trust established to accumulate and hold a portfolio of the equity securities that comprise the Dow Jones Industrial Average, according to the American Stock Exchange (AMEX). The DIA, or Diamonds, seeks investment results that, before expenses, generally correspond to the price and yield performance of the DJIA.

Puts are popular on the DIA today, as traders look to capitalize on the ETF's nearly 3% decline. Specifically, put volume has ballooned to some 32,000 contracts, more than doubling the DIA's average daily put volume. The most active strike is the November 90 put, where more than 13,000 contracts have changed hands. What's more, another 13,000 puts have traded at the November 92 strike. Open interest at these front-month options totals roughly 9,000 contracts each.

Drilling down on activity at DIA's November 90 put, I noticed that two blocks, totaling 8,457 contracts, traded at 10:36 a.m. Eastern time on the International Securities Exchange (ISE) for the ask price of $0.30. These trades were marked "spread." The second leg of this position was found on the November 92 put, as 8,457 contracts traded at the same time on the same exchange for the bid price of $0.43. These blocks were also marked "spread." Given this data, we could be looking at the initiation of a short vertical put spread, or a credit spread, on the Diamonds Trust.

The Anatomy of a Diamonds Trust Short Vertical Put Spread

Getting down to business, the trade breaks down like this: The trader pays $253,710 for 8,457 November 90 puts -- ($0.30 * 100) * 8,457 = $253,710. Meanwhile, the trader receives a credit of $363,651 for selling 8,457 November 92 puts -- ($0.43 * 100) * 8,457 = $363,651. At this point, the trader has pocketed a premium of $109,941 -- ($363,651 - $253,710) = $109,941. The breakdown for this short vertical put spread is listed below:

Breakeven for this trade is equal to the sold strike minus the premium received, or 91.87 -- 92 - ($0.43 - $0.30) = 91.87. The maximum gain is equal to the total premium received -- $109,941 -- while the maximum loss is limited to the difference between the November 90 put and the November 92 put, minus the net credit received, and is reached if DIA trades at or below $90 per share on expiration. In this case, the maximum loss is $1.87, or $187 per contract -- (92 - 90) � 0.13 = $1.87. Below is a chart for a visual representation:

DIA short vertical put spread profit/loss chart

Implied Volatility

After the short vertical put spread has been established, increasing implied volatility is pretty much neutral to the overall position, as it lifts the value of both the sold option and the purchased option. Currently, implieds for the November 90 put arrive at 29%, while the implied volatility for the November 92 put rests at 26%. DIA's one-month historical volatility is currently perched at 16.39%, meaning the aforementioned options are considerably expensive at the moment.

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Options Update: Dell Inc. Short Strangled Ahead of Earnings

(11/19/2009 2:15:00 PM)

After the close of trading tonight, Dell Inc. (DELL: sentiment, chart, options) is expected to report a third-quarter profit of 28 cents per share, down from earnings of 37 cents per share for the same quarter last year. Historically, the company has bested the consensus estimate in each of the prior four reporting periods, with an average upside surprise of 6.1%. Heading into the event, volume on both sides of the put/call coin has nearly quintupled Dell's daily average. Some 16,500 puts and 31,000 calls have changed hands so far today, with traders focusing most of their attention on the December 17 call and the December 15 put.

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Options Update: Short Straddling The Walt Disney Co. Post-Earnings

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With stocks losing favor ahead of the open, the U.S. Dollar Index is once again benefiting from a safe-haven bid, gaining 0.21% to 75.23 in pre-market activity. Meanwhile, the December gold futures contract has added $1.40 to $1,116.20 an ounce. Finally, crude oil for January delivery is down 56 cents, at $79.36 per barrel in electronic trading.

Wal-Mart Stores Inc. (WMT) reported that third-quarter earnings rose to $3.24 billion, or 84 cents per share, from $3.14 billion, or 80 cents per share, a year earlier. Sales rose to $99.4 billion from $98.3 billion. Analysts were expecting a profit of 81 cents per share on sales of $99.2 billion. Wal-Mart forecast fourth-quarter profit of $1.08 to $1.12 per share, and raised its full-year outlook to $3.57 to $3.61 per share. Wall Street is currently looking for earnings of $1.12 per share in the fourth quarter and $3.58 per share for the year.

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Options traders appear to be split down the middle when it comes to prospects for General Electric Co. (GE: sentiment, chart, options). For instance, the stock's Schaeffer's put/call open interest ratio (SOIR) of 1.00 indicates that put and call open interest is practically dead even among options with less than three months until expiration. Furthermore, GE's SOIR also ranks near the middle of its annual range, underscoring the relatively mixed view among options speculators.

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(11/6/2009 1:00:00 PM)

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Options Update: A Diamonds Trust Short Put Spread

An options trader pockets a premium in a vertical put spread

by Joseph Hargett (jhargett@sir-inc.com) 10/30/2009 3:10 PM

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