Toyota Motor (TM) “stalls” amid continued recall news

Toyota Motor (TM) option strategies The recall drama isn’t over for Toyota Motor TM, which last week announced the recall of 1.1 million 2008 Corolla and Matrix vehicles, citing engine control troubles. The potential flaw may result in stalling, which is ironic given that the automaker’s recent high-profile recall dealt with unwanted acceleration.

There hasn’t been any acceleration in the stock of late – unwanted or otherwise. Since mid-June, the stock has been see-sawing between the 68 and 74 levels. At their current perch, TM is within a chip-shot of its 52-week low and 25% south of its 52-week high, reached in mid-January.

Range-based trading such as Toyota’s can be frustrating for stock traders who see their investments heading nowhere fast. The options market, however, has some potential solutions for sideways-trending stocks, and the short straddle described below is one of them. We’ve also outlined a bearish put ratio spread for investors who believe this latest recall could spur further downside in the shares.

These are not trading recommendations, merely examples of different options trading strategies for educational purposes. The prices are taken as of Friday afternoon, when TM shares were trading at $69.15, up 43 cents on the day. For a full dissection of the strategies including profit/loss information,

Neutral Option Strategy: Short Straddle

Investors who believe TM shares might indeed be stuck in neutral could short the October 70 straddle. The simultaneous sale of the October-dated call and put would yield a net credit of $4.95.

At expiration, the maximum potential gain is the $4.95 credit collected. The investor keeps this if TM expires right at the 70 strike (requiring a slight pop higher in the shares). Between $65.05 and $74.95 (the strike price minus and plus the credit), the short straddle is in positive territory at expiration.

Losses are unlimited with a short straddle if the stock rallies. On the downside, losses are unlimited down to zero, or $65.05 in this example. Remember that a straddle strategy can only lose in one direction at expiration. Note: both charts below were created with the profit/loss calculator tool in a virtual trading account.

Bearish Option Strategy: Put Ratio Spread

Bearish investors might consider the put ratio spread strategy, containing two short out-of-the-money puts and one long near-the-money put, such as the long October 70 put and two short October 65 puts. The net debit for this three-contract spread is approximately 98 cents.

Maximum potential profit, if the stock is trading right at the 65 strike at expiration, is $4.02, which is the difference in strike prices minus the premium paid. The breakevens for this strategy are $60.98 to the downside (the short strike minus the maximum profit potential) and $69.02 to the upside (the long strike minus the debit paid).

To the upside, the maximum risk is capped at the 98-cent premium per spread if TM shares are trading above 70 when the options expire. Downside risk for the short put is substantial if the stock declines dramatically. While the loss potential is often described by professionals as “unlimited,” there is technically a finite (if sizable) maximum as stocks cannot trade below zero.

Toyota Motor (TM) put ratio spread