Adam Warner, at Daily Options Report, got some email on FNM and FRE and discusses how he’d set up a bullish play – why? Because he expects "a quick short-squeezing double on the way to zero." The "on the way to zero" part isn’t reassuring, but a double would be good for now.
Viewer Mail
Got this in email yesterday:
Looking at FNM this morning it was trading 4.85. The Sept 5.00 call was trading about 1.25. I realize this is just because the vol has blown out and selling this vol is probably the right thing to do. Were it a more normal situation I know a strangle, straddle, butterfly or condor would be the way to play this. (But not possible here because no reasonable strikes below atm.)
One of my friends suggested writing the 5 call and buying the stock… doing a covered call to sell the vol. this seems wrong to me intuitively but I can’t articulate why. If you were hell-bent on writing options here writing a call spread in sept (5/6 5/7 etc) would probably be the way to go, but I can’t explain to him in simple English why the covered call strategy is a poor choice here.
Giuseppe Franco
Wow, didn’t realize you owned the company (or anything about it). Or were an options trader.
OK, confession; that’s not the emailers real name. Here’s my response.
I guess it all depends on the direction you want to play for. If you want to play a direction at all.
A covered call write is almost exactly the same thing as a naked put sale, so it’s a bullish play. Selling a call spread is a conservative bearish play, you’ll max out if the stock closes under 5. You only risk (1-the spread premium) but can only make the spread premium.
If you want to simply sell the volatility, and don’t have a directional bias, the proper play is to sell either straddles or strangles on a delta neutral basis. By delta neutral I mean either sell calls and puts with the same delta, or tweak the quantities a little bit.
In a follow up email, Guiseppe admitted he knew a covered call was the same thing as a naked put, but "our reaction to the short put was “no way” while, for some reason, the covered call seemed acceptable…….biases are funny things, no?"
Yes on the biases, and it’s pretty easy to see why Giuseppe says that. Everyone on Wall Street tells us so. Covered calls are considered some sort of "safe" income generation, while naked puts are for insane dice-rollers. Yet they have exactly the same risk/reward profile. P&L’s might differ modestly as interest rates and dividends fluctuate, but for all intents and purposes they are identical. And in fact put sales were wildly more preferable until they adjusted margin treatment a couple years ago (the stock and the call did not offset for margin purposes).
Bottom line is that both are conservative bullish plays, especially in a stock that is already a call option in and of itself. If you are wildly bullish on FNM equity for whatever reason, better to just buy the stock. It’s highly likely somewhere, someday, someway (great Marshall Crenshaw song by that name btw, can’t find the real video though, so here’s "Whenever You’re on My Mind") FNM and FRE will do a quick short-squeezing double on the way to zero. That double might be 2 to 4, but it happens at some juncture every time.
