2010 has been a solid year for Coca-Cola KO. The blue chip has risen roughly 15% year to date and is up 25% from its early-July low. Shares of the soft-drink titan are now trading around the $65 level, at their highest point since last millennium.
It's times like this that try traders' souls. Do you go with the trend or look for a pullback? Is Coke likely to continue its ride higher or take a breather?
Citigroup is in the bullish camp, recently upping its price target to $72 from $65 (and maintaining a “buy” rating). The firm also lifted its earnings estimates for the company, citing “higher expected merger synergies.” In fact, all of Wall Street is optimistic toward KO; the OptionsHouse Research tab indicates that all 16 of the analysts following the stock have named it a “buy” or an “outperform.”
Coca-Cola bulls might want to consider options trading as an alternative to buying the shares outright. Those who want to take a contrarian view might opt for an options strategy instead of shorting the shares.
We have outlined two option strategies below – one near-the-money long call that could be considered a “stock replacement” for bullish investors. For the bears, we have outlined a put ratio spread. These descriptions are for educational purposes only and do not constitute buy/hold/sell recommendations. All prices were taken at last Tuesday's close, when KO shares were trading at $65.49, up 18 cents for the session.
Bullish Option Strategy: Long Call (Stock Replacement Strategy)
Investors expecting continued upside in KO shares could buy the at-the-money February 65 calls for $1.86, gaining upside exposure to the shares. This call currently has a delta of 60 so will theoretically gain 60 cents for every $1 advance in KO shares (and will conversely lose 60 cents for every $1 decline). Delta is a fluid indicator that will change based on shifts in implied volatility and the price of the underlying.
At expiration, delta is either 100 (if the call is in-the-money) or zero (if the call is out-of-the-money). Above the breakeven price of $66.86 (strike price plus the premium paid), gains are theoretically unlimited for the call position. Losses, however, are limited to 100% of the $1.86 paid, no matter how far KO might decline. The chart below was built with a profit/loss calculator, part of an OptionsHouse virtual trading account.
Bearish Option Strategy: Ratio Put Spread
Those expecting near-term downside from KO could look into a ratio put spread, a strategy that calls for the shares to decline as far as a certain point (and then stop). Investors could buy one February 65 put and simultaneously sell two February 60-strike puts. The net debit to trade this is currently 75 cents (plus commissions).
At February expiration, the maximum potential profit is $4.25, or the difference in strike prices less the premium paid. The investor collects the maximum profit if KO is trading right at the short strike (60) when the options expire. The breakeven prices for this trade are $64.25 to the upside (the long strike less the premium paid) and $55.75 to the downside (the short strike less the maximum profit). The trade provides a bearish hedge of about 8.5% down to the 60 strike from its current price.
If KO were to rally, the investor risks only 75 cents (as upside losses are capped at the premium that is paid). Downside risk is significant, however, because of the uncovered short put that is in-the-money below 60 (the other short put is effectively cancelled out by the long put). If KO shares were to decline sharply and breach the $60 mark, losses would be equal to that of a long stock position below the 55.75 downside breakeven point.
The above information is provided by OptionsHouse, LLC (“OptionsHouse”) for informational and educational purposes only and is not intended as trading or investment advice or a recommendation that any particular security, transaction, or investment strategy is suitable for any specific person. You are solely responsible for your investment decisions. Commentary and opinions expressed are those of the author/speaker and not necessarily of OptionsHouse. Neither OptionsHouse nor any of its employees, officers, shareholders or affiliated companies guarantee the accuracy of or endorse the views or opinions of guest speakers or commentators. Projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature and are not guarantees of future results. Any examples used that discuss trading profits or losses may not take into account trading commissions or fees.
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