Option Purchase to Open MOTQE

On Friday we bought a $25 May 2006 put option on Motorola (MOT) for $2.50/option. Their Q1 earnings report earlier in the week gave a very strong sell signal according to 4 technical indicators: price broke downward through 30-day average, macd turned negative, stochastics broke downward through the 75% mark, under very heavy volume (53M shares vs. a 52-week average of 20M). Though their company fundamentals aren’t too bad, their stock group Technology/Communications Equipment is on the down-turn, so this looked like a good opportunity for a 1-month put option play.

We’ll discuss exactly what a put option is on a non-trading day, but for now these are the steps that were taken for choosing the best option. We went to http://finance.yahoo.com/q/op?s=MOT&m=2006-05 and copied and pasted the put option table that expires in May of 2006 into a spreadsheet. We then created an ROI (Return On Investment) table for the range of target prices from 20-25. This range was chosen because the stock has been fluctuating in the 20-25 price range for the past 9 months. Balancing safety with profitability, it seemed the $25 strike price was most attractive. If MOT closes at $22.50 on May 19, we break even (minus brokerage fees.) If it closes at $22, we make 20%. If it closes at $21.50, we make 40%, etc.

Our exit strategy is to sell all the options prior to the option expiration date of May 19 if the stock price hits or drops below $20.55. This price was chosen from observing price resistance at around $20.50 for the past 6 months. Our online broker conveniently allows an options trade to be triggered by behavior of the underlying stock. A trade trigger was set to sell all options if MOT hits or drops below $20.55.

Options trading can be very risky. For example if MOT closes at $24 on May 19 and we have not yet sold our options, we lose 60% of our investment. If it closes at $25 or higher we lose 100%. Today we are up 16%. Not bad for 1 trade in 1 day. But these tempting returns attract many investors into trades that will take the shirt off their back.


2 Responses to “Option Purchase to Open MOTQE”

  1. memelab says:

    Thanks for taking the time to put together this blog. I am wondering whether enough historical information exists, on sites like yahoo, to produce technical profiles from the past, to see what kinds of indicators may or may not have existed that announced what we now know as true. For instance, would an analysis of RHAT 1 year ago have pointed to BUY (it has since gone up over 100%)

    Also, does technical analysis work for all kinds of stocks or only those that express certain characteristics through their fundamentals (i.e., positive earnings, minimum threshold of trading volume or market cap, etc.)

  2. This motivates this post on our general investing strategy that also includes links to definitions of the indicators used. Perhaps this puts things into a larger context that addresses your comments.

    Yahoo’s finance site contains a lot of good information and is one of our favorite free sites. To access historical technical data on RHAT, click on the “Technical Analysis” link on the left side of the page.

    We would never invest in a stock based solely upon technical analysis. There are plenty of instances where the primary technical indicators would give a buy signal, but where the company fundamentals are poor and consequently lead to a quick reversal in the direction of the stock. Ultimately we try to take a holistic approach to our investments and use as much important information as possible, weighing time spent analyzing with execution. So to answer your second question, technical analysis can be applied to all stocks, but is only one tool out of a more complete set of tools for analyzing an investment.