Tuesday's Hot Stocks: One Fahionable Option Trade

With the major indices trading slightly higher Tuesday, there were 28 stocks which broke higher on BIG volume. If this is your first time reading one of my breakout reports you'll want to read the section below, however if you are familiar with my daily breakout report you should skip ahead to the list of stocks.

To reiterate previous blog posts like this, the first thing I do is scan the list for familiar names, such as stocks I am quite familiar with or ones which have appeared on similar scans multiple times in the past week or two (most of these names are unfamiliar so it saves a lot of time). This indicates there may be some real momentum behind the stock, and that it could trade higher in following sessions as well. Then (if and when any of the stocks I find are familiar to me), I make sure the stock has options available to trade, and then take a look at the chart(s) to see if I can structure a potential option trade. The list in this post includes 28 stocks, all of which traded higher on heavier volume Tuesday March 2, 2010. Many times I find an option strategy I plan on opening if I am convinced some money can be made.

The table below shows the company, ticker, per share % increase, and volume increase (% increased compared to 50 day average). For your convenience I have ranked the stocks in order from greatest to least volume % change.

Out of the 28 stocks above, there are quite a few which I have already outlined potential option trades on in previous posts, therefore if you follow my posts you'll definitely want to see the update section below. Out of Tuesday's breakout stocks on big volume, one which I have been debating opening an option strategy on for some time is Steven Madden, Ltd. (SHOO), however at this point I believe the stock is overbought and I would like to wait for a pull back to get long. First I will give a company summary from Google (GOOG) Finance below.

Steven Madden, Ltd. designs, sources, markets and retails fashion-forward footwear for women, men and children. The Company also designs, sources, markets and retails name brand and private label fashion handbags and accessories through its Daniel M. Friedman Division. The Company distributes products through its retail stores, its e-commerce Website, department and specialty stores throughout the United States and through special distribution arrangements in Canada, Europe, Central and South America, Australia and Asia. Its business comprises three segments: Wholesale, Retail and First Cost. Steven Madden Retail, Inc., its wholly owned retail subsidiary, operates Steve Madden and Steven retail stores, as well as its e-commerce Website. Its wholly owned subsidiary, Adesso-Madden, Inc. acts as a buying agent for footwear products under private labels and licensed brands for many mass merchandisers and mid-tier department stores. In February 2010, the Company acquired Buddha, Inc.

Steven Madden (SHOO) reported earnings the morning of February 25, 2010, gapped higher and closed much lower (opened at 43.58, closed at 41.99; a rather bearish chart pattern and a potential reversal signal), the following day the stock traded in a big range (high of 42.94, and low of 41.23) but bulls managed to dominate and SHOO closed nearly unchanged, just 2 cents higher, SHOO seems to have regained its footing and on March 1 & 2 the stock has exploded to the upside on larger volume. As stated before, the day of earnings signaled a very ugly chart pattern to me, and I believe SHOO would have sold off if it was not helped by Deckers (DECK) reporting earnings the evening of February 25. As stated I believe SHOO is a bit overbought, but based on the current chart I certainly wouldn't short it here, so I will outline a potential option trade that will get me into the stock lower if SHOO sells off, but will allow me to participate in gains if the stock continues higher, sideways, or even lower by as much as 10% over the next 17 days.

Steven Madden Vertical Put Spread: As stated I wouldn't mind picking up shares of this stock if it traded lower, and based on the chart and bollinger bands I don't believe seeing the stock down near the 40-38 range is impossible. Instead of setting a limit order to purchase these shares, I have decided to sell March 40/35 vertical put spreads, that way if the stock continues higher I will also return slight gains, instead of just having a good until canceled limit order. Using current market data, this strategy could be opened for a net credit of $25 per spread or 5% return on maintenance (less any commissions) in 17 calendar days, but I plan on placing my order on weakness in the underlying to try and get a bit more premium than current levels.

Profit & Loss: Assuming I could open this option position for the prices outlined above, my maximum risk is limited to $475 per position, this will occur if SHOO sells off and closes on March options expiration at or below 35 per share. This position will achieve maximum profitability if SHOO closes above 40 per share on March options expiration (10.17% lower than Tuesday's close price), returning $25 profit per option spread (less any commissions). The break even point for this strategy is SHOO at 39.75 per share at March options expiration (less any commissions), anything below 39.75 per share at expiration will result in an unrealized loss on shares of SHOO (assuming the position is not closed and is exercised).

This should not be considered if you think the stock will sell off by more than 10% in the near future. However if you feel the stock could move higher or sideways in the near future, this strategy could yield a nice gain. To get a better understanding of stock options and different option strategies please check out my Simplified Stock Option Trading E-Books.

Updates to Previous Posts:
First it is important to note that I traded entirely out of my China Agritech (CAGC) March Vertical Call Spread position Tuesday as I noticed immediate weakness following a huge gap higher at the open. It looks as if the daily chart is marked with a very ugly bearish engulfing candle pattern, and I would not want to be long this stock here.

Second I lightened up on my Sirona Dental (SIRO) position after witnessing the stock reverse off the higher end of the bollinger band near 38 per share. The chart still looks okay on Sirona, however this was my signal to lighten up.

Third, going way back to my Sirius (SIRI) buy-write option strategy outlined on February 2, 2010, I believe that identical strategy could be considered at these levels. Going into the close Tuesday, I purchased additional shares of Sirius as it looked like it had a reversal day and the short term bottom may be in (gapping lower at the open, trading as low as 82 cents, and finishing the day in positive territory; having its second highest volume day in the past 52 weeks, only to the day Sirius got booted from the Russel Index on June 26, 2009). I hope to write the shares out for the March options expiration on strength in Sirius, however I may have to write them out for April.

Last but not least another update to Rovi Corporation (ROVI). After outlining a bullish option strategy on February 24, I made an important update to the post on February 25 stating a very bearish pattern had emerged and it was likely to show some short term weakness. ROVI showed weakness the following three days, but finally broke out again Tuesday voiding that bearish chart pattern and actually setting a new 52 week high. I might reconsider opening the option strategy outlined in my post on ROVI, however I think I would rather purchase shares of the stock and set a tighter trailing stop loss, as ROVI has just been far too volatile lately.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

The reason option volumes have surged in the last five years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: Long NTY March 45 Call Options, SIRI, SIRO March 40 Call Options, SIRO April 25 Put Options, Short RINO March 20 Put Options, SIRI March 1 Call Options, SIRO April 30 Put Options