Get an Extra Kick While Waiting for Nike's Earnings
Its shares are stagnant, allowing more than three weeks of time decay to collect some option premium.
After years of enjoying double-digit growth and an accompanying stock price that produced a swoosh-like chart, shares of Nike (NKE) recently flatlined, trading between $62.50 and $66.25 for the past five months. In percentage terms, this 5% range is the narrowest trading band for a five-month period for over the past five years. The 60-day historical volatility on the stock has sunk down 12.5%, also a multi-year low.
Just Don't Buy It
It's tempting to assume that the stock is now "due" for a breakout and it still might be premature to be buying options on the name. Like any price pattern, it's never safe to underestimate the persistence of a trend, and sideways is no different than up or down. It can continue for much longer than one thinks it should. And while a sideways market won't make you suddenly insolvent like a strong directional move can, owning options during it can steadily drip away at your assets.
Part of Nike's funk is simply because of the overall slowdown in consumer spending and the uncertain outlook across the globe. As an international company, it also lost some of the tailwind provided by the weaker dollar during most of 2009.
Some company-specific problems include that it's no longer the dominant, must-own brand. It also lost some high-profile marketing presence with the absence of Tiger Woods and Adidas' sponsorship of this summer's big sporting event, the World Cup.
Earn While Waiting for Earnings
The March 17 earnings report could provide a price catalyst, but until then I think the stock could remain stuck in this range. That gives us more than three weeks of time decay to try to collect some option premium. Right now, Nike options have an implied volatility of around 22% which, while it's not a high number in absolute terms, is relatively high compared to the historical volatility at the 14% level.
A good strategy for benefiting from a range-bound stock is an iron butterfly. This is basically the sale of straddle, that is the sale of both puts and calls with the same strike price, combined with the purchase of puts and calls that have further out-of-the-money strikes. Looked at another way, this is essentially the simultaneous sale of both a put and call spread.
For example, with Nike trading $64.50 a share, one can sell the April $60/$65 puts spread for $1.75 net credit. One can sell the April $65/$70 call spread for a $1.40 net credit. That is total credit of $3.15 of premium collected. That would also represent the maximum profit if shares of Nike were at $65 on the April 16 expiration day. The maximum loss would be $1.85 if shares were below $60 or above $70 on expiration.
Given the attractive risk/reward, I'd be tempted to hold the position through earnings given the fact that implied volatility will likely decline further following the report.
But if one doesn't want to risk a gap-price move, there would be no need to wait until expiration to reap a profit. Let's assume one wanted to take off the position two days before the earnings report, or on March 15. Let's also assume the shares are still in the $64 to $65 range. The 18 days of time decay would have whittled down the value of the iron butterfly to $2.70, a $0.45 or a 15% profit for the three-week holding period.
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