How One Investor is Using Options to Manage Risk in Weyerhaeuser (WY)

Weyerhaeuser (NYSE: WY) is a grower, harvester and distributor of lumber around the world. WY is primarily focused on supplying lumber for many construction applications specifically, new home construction.

WY, expected to lose money this quarter, will report earnings on April 29, 2010. The company’s stock has been moving slowly higher over the past couple of months to its current trading level of $47.75.

This week, the all-important housing data will be released. Existing sales will be announced Thursday, and new home sales on Friday. These numbers typically influence WY stock even though the company’s earnings can be a gauge of consumer strength and building activity, depending on whether they report strong or weak lumber delivery.

Regardless of what you may think about the future of housing in America, one investor was using options to create a hybrid long stock synthetic position using a long call and a short put with different strikes.

This type of trade is called a risk reversal and gives you unlimited profit potential. Your risk is limited to the put strike that you sell, plus or minus, any credit or debit you pay or receive. The risk reversal can push downside breakevens lower than the current stock price.

Today, an investor in WY bought the January 55 call and sold the January 40 put for even. This means they did not pay or collect anything to do the trade.

While this trade has unlimited profit potential, there is a caveat, if WY finishes anywhere between 40 and 55 on January expiration, this trader may not make anything (or lose anything for that matter). If the stock were to drop to 40 or below, this trader can lose up to $40.00. If the stock climbs above 55, anything above that becomes profit as long as the trade remains in force. The trade can win or lose with WY between $40 and $55 before expiration, so be sure that you keep that in mind if you’re examining this trade.

At the end of the day, this is a bullish trade where you use the premium from the short put to finance the purchase of a long call, both options are typically out of the money and generally traders tend to put these trades on with longer durations to (hopefully) allow the stock time to rise.

This was a unique trade we happened to see come through today, so I thought I would share it with you to illustrate some of the different ways options can be used to manage investment risk.

Coping with Risk

Options provide investors with many opportunities to apply different strategies to their investments depending on what they think will happen next in the market. What is your strategy for managing the risk in your investment portfolio? Feel free to share your ideas in the comments, or ask any questions that might have you feeling stuck.

OptionsHouse has some of the most competitive rates in the brokerage industry for trading stock options. If you’re new to options, start practicing your trades in a virtual trading account.

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