Wednesday, January 11
CMED, Legging out
We paid $1.50 for the CMED Jan 35-40 call spread--buying the Jan 35 calls and selling the Jan 40 calls--and since the stock has met our expectations we are looking to get out as the stock hits a ceiling at $40.
But CMED presents a problem common to stocks with illiquid options markets; the bid-ask spread is wide and we don't want to give that much money away.
On tuesday the stock closed at $39.41, and the Jan 35 calls, the part of our spread that we are long, was $4.60 bid, at $5.40--$.80 wide. Too wide.
We'll put out an offer to sell this Jan 35 call at $5.80 and see what happens. Why?
If the rest of the market is neutral we can bet that CMED will make another attempt at crossing above $40, even if it does not close above it. When it does make the run, those Jan 35 calls, which are deep in the money, will move up almost as much as the stock itself.
So if the stock moves up the required $.60 to hit the $40 mark, the calls should move up, let's say $.50. The $5.40 offer on the exchanges will rise to $5.90 uncovering our offer at $5.80--and we will become the best one; the next to sell to those momentum call buyers.
Even if the professionals keep lowering their offer to remain the best one, the stock may continue to rise and they will be forced to fade and maybe buy our call themselves in order to get us out of their hair.
Once we sell the 35 call we can pay the offer on the Jan 40 call or work out of it, and we will be out of the spread.
In the real world you can react to the market in real time, but it is always good to go into the trading day with a plan. As old Gomp used to say "ya've gotta have a plan". Of course that always included a sixer of King Cobra...