ROVI Earnings Play

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Current Trades:

Current Payout:
Strategy:
February premium ATM calls are trading at over 80% volatility so 1 FEB 65 CALL and 1 FEB 70 CALL were shorted into earnings to collect premium against the long MAR 65 CALL bought on 1/28/11. In the event that ROVI misses earnings and the stock drops below 65 until Friday expiration then premium of 2.15 is collected lowering the risk of the MAR 65 CALL from 4.80 to 2.65 (2.40 * 2 = 4.80; 4.80 – [1.40 + 0.75]).

The MAR 75 CALL was bought today for two reasons:

  1. Unlimited upside potential in the event of higher than expected reported earnings
  2. Gives me more flexibility in the future if I want to put ROVI gains into a neutral spread (if the price of the 75 CALL drops then I can add one for cheaper to lower the basis and leg into the spread when price recovers; if price goes up then the deltas in the 70 strike will increase faster than the 75s so I can short 4 70s to offset the 75 CALL to spread the position; or at that point I could sell 1 65, and 2 70s for a spread)

Goal:
Lock in profit with potential for further gains.

Deltas for 70 and 75 MAR CALLS are .33 and .16 respectively when ROVI trades at 65.40. If a butterfly spread is legged on at 66.50 the premium will be approximately 2.00 and 0.90 respectively for the 70 and 75 CALLS. The benefits of this are as follows:

  • It would free up capital of $710 for other trades
  • The butterfly is on for a credit so the maximum risk of loss is a gain of $165 (if the stock closes at 65 > close > 75)
  • The maximum profit potential is $1,165 (if the stock closes at 70)

Anticipated Payout:

PG Butterfly Arbitrage

Goal:
Convert April PG position to risk-less butterfly arbitrage. Profit from APR 67.5 CALLS not included in credit.

Holding:
+1 APR 62.5 CALL @ 1.85
-1 APR 65 CALL @ 0.85
+5 APR 67.5 CALL @ 0.17

Zero-Risk, Zero-Profit Position:
1.85 + 0.17 = 2.02
2.02 – .85 = 1.17

Trades:
-1 APR 65 @ >= 1.17 (current mkt val = 1.29)
-4 APR 67.5 @ 0.42 (current mkt val)

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Since the zero-profit position comes from the sale of 1 APR 65 CALL @ 1.17 then anything above that locks in profit at $1/cent above 1.17.

The maximum profit at expiration is $250 if the underlying closes at 65 on 4/15/11 and the 65 CALL is sold at 1.17.

Profit will be higher from the sale of the 4 APR 67.5 CALLS currently held but this is not included in the calculation for the arb.

Since the spread has been “legged” into starting from the long side, the higher the underlying goes before the CALL is sold the higher the profit is that gets locked in.

NOTE: The simulation uses the closing market value for the short APR 65 CALL. This position has no risk of loss to expiration.

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Goal:
Maximize profit in butterfly arb using unrealized profit in APR 67.5 CALLS and APR 62.5 CALLS.

Holding:
+1 APR 62.5 CALL @ 1.85
-1 APR 65 CALL @ 0.85
+5 APR 67.5 CALL @ 0.17

Trades (closing mkt value used for simulation on all trades):
+1 PG APR 62.5 CALL @ 2.90
-3 PG APR 65 CALLS @ 1.29
-3 PG APR 67.5 CALLS @ 0.42

Increase in Buying Power:
1.29 * 3 = 3.87
0.42 * 3 = 1.26
3.87 + 1.26 = 5.13 credit
5.13 – 2.9 debit = 2.23 credit (increase in buying power)

Final Position:
+2 PG APR 62.5 CALLS @ 2.375 (averaged w/mkt value)
-4 PG APR 65 CALLS @ @ 1.18 (averaged w/mkt value)
+2 PG APR 67.5 CALLS @ 0.17 (profit not included)

Maximum Risk of Loss:
2.375 * 2 = 4.75 debit
1.18 * 4 = 4.72 credit
0.17 * 2 = 0.34 debit
3 * (0.42 – 0.17) = 0.75 credit (profit from APR 67.5 CALLS)

-4.75 + 4.72 – 0.34 + 0.75 = 0.38 credit (maximum loss is a credit; therefore risk-less)

Maximum profit potential is $538 on 2/4/2 vs $262 on 1/2/1 butterfly if underlying closes at 65 on 4/15/11.

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