Volume Talks: Hot Stocks on Heavy Volume & Detailed Earnings Option Trade

In this post, I will name 25 stocks which traded higher Wednesday November 18, 2009 on unusually higher volume. As always, I will keep an eye on these stocks Thursday to see if there is continued buying pushing the stocks higher. This method is just one of the ways I use to pick stocks to structure particular option trades. The second part of this post requires the knowledge of stock options. To learn more about the option strategies outlined in this post, risks, pricing, calculations, other strategies, and options in general, click here.

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.

The list above contains many stocks which I have seen appear multiple times while screening for these stocks. This list is also packed full of stocks I have been keeping an eye on and would like to own as I think they will trade higher. Out of the stocks listed above, I will write about Sirona Dental Systems (SIRO). With the help of the market, I believe this stock will continue to outperform. I believe it will be worth describing a detailed option play I am interested in below. Note that many of the stocks listed above will be good plays and many will be bad plays, I list them all to show possible breakout stocks and write about a few of the ones I am interested in. (Click chart to enlarge).

I would become a buyer of this stock if it can trade above 30.50 a share, and would like to see it continue trend past 31. However with earnings for this stock scheduled to be released December 4, 2009, I may wait and use a different method of playing this stock. I would structure an option trade that would capture the increased levels of implied volatility in the option contracts leading up to the earnings report.

Earnings Option Trade: Although the recent chart and a break above 31 would be bullish for the stock, it could all change after the earnings report. I would look at opening the following strategy to get cash up front, cap my losses, and still get unlimited gains. As earnings approach the options will factor in a bit more volatility, causing the premiums to be a bit overpriced, therefore I would look to be a seller of Vertical Put Spreads and a buyer of Out of the Money Call options. Although this stock reports earnings in just over two weeks, I will give this example using current market data.

I would first open the vertical put spreads by selling the December 30 strike put options and purchasing the December 25 strike put options against them (1 for 1). This would give me a credit of $115 per option spread (putting $115 into my portfolio), as well as limiting my downside risk to $3.85 a share (after taking into account the credit). I would then look to purchase out of the money calls with the cash received (1 call per option spread). If I were to purchase the December 35 strike call options, this would cost $20 (at the ask price) per option contract. The strategy now has unlimited upside potential and also limits the loss to $4.05 per share, even if the stock sells off significantly and closes below 25 a share at the December options expiration. The break even for this strategy is $29.05 a share, which is 3.9% lower than the current share price, so if the stock moves sideways after the earnings announcement this strategy will also be profitable.

Note that depending on the share price as earnings approach will determine the strikes used to structure this trade. One negative about this stock is that volume is light meaning it may be tough to fill option orders. I will likely wait until December 3 to open this position, as it will take advantage of the increased option premium due to earnings the following day.

This is a bullish strategy and should not be considered if you think the stock will sell off after earnings. However if you feel you've missed the stock and think it could move sideways or up after the report, 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. 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: No Positions