Even when your prediction about a stock is wrong, a good options strategy can protect you where a pure-stock play can’t.
Case in point: Bank of America .
On last Friday's debut of "Options Action," Mike Khouw, who also runs Cantor Fitzgerald's U.S. Equity Derivatives Trading desk, recommended a simple options strategy for those tempted to play a potential BofA bounce: buying what's called a call spread.
"If you want to make that play, if you want to say the financials have an opportunity to rally, I don't think you want to buy the stock for $7 bucks," Khouw said.
Instead, he recommended buying the Bank of America May 10/15 Call Spread. In this trade, the options investor buys the BofA May 10 calls for $1.20, and offsets that purchase by selling the BofA May 15 calls for $0.40, for a total cost of $.80. (Note, prices for those contracts have since changed). His upside is the difference between the two strike prices ($500), minus the cost of the trade, in this case $80. (Options contracts are priced to 100 shares).
If the logic is clear, the math is even better. If he simply bought 100 shares of BofA last Friday, he would have paid about $700 bucks and lost around $200 by the time the market opened on Monday. But by suggesting the May call spread, he only risked $80 for the possibility of making $500.
So far, the trade has not panned out. BAC is down, but Mike’s May call spread is trading for about $0.60.
So let's break it down. If you bought BAC shares outright last Friday, as of 3pm today, including today's rally, you'd be out about $110 bucks. But if you bought the call spread for $80, you would have only lost $20: the price of the May 10/15 call spread Monday ($80), minus the current price for that trade, ($60).
Not great, but certainly better than a sharp stick in the eye.