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Wednesday, April 29, 2009

Visa on Deck to Report Earnings Option Straddle VS Option Strangle

With Visa on deck to report earnings after the bell on April 29, 2009 some option strategies come to mind right away. Although Visa is not a financial it has been tracking like one for the majority of the time it has been listed. Let's compare Visa to American Express, although Visa is only a transaction provider and has no business collecting money like AXP whatsoever. However it is the closest financial we can compare Visa to because they both involve credit cards. Assuming V reacts like AXP, Visa will have a huge move (20%+).

If Visa beats significantly we could see a 10% move up in the stock or about $6, if they miss we could also see a 10% drop in the stock or about -$6, based on today's close price for V at $60.71. Below are two option strategies to play before earnings. One is playing the option straddle, and the other is playing the option strangle.

Playing the straddle. The current ask for the May 60 PUT option is $260 per contract and the current ask for the May 60 CALL contract is $330. The total for 1 contract of each would be $590. Using the current Delta and assuming Visa beats and moves 10% up or $6.07 after earnings, the CALL contract will get to at least $670 (however the delta would increase with the price increasing, therefore each $1 move up would increase by more than the delta I used for this example), while the PUT contract drops to $0 (with delta used in this example), however this is not the case because just as delta increases as the option is further in the money, the delta decreases as the option is farther out of the money; this means each $1 up will result in less of a decrease in the PUT contract- meaning it will still likely go for something. Again using the current Delta and assuming Visa misses and moves down 10% or $6.07 after earnings, the PUT contract will get to at least $520, while the CALL contract drops to $0 (however the same rules apply but just the opposite).

Therefore assuming Visa will be very volatile this may be a good trade, however if Visa is stable after earnings this straddle could be a disaster.

Now let's analyze playing a strangle before earnings on Visa. With Visa being closest to the $60 strike we would pick the two closest strikes surrounding the Visa 60 which are the 57.50 and the 62.50 for May. The current ask for the May 57.50 PUT option is $160 and the current ask for the May 62.50 Call option is $205. The total to open this strangle position would be $365. Now lets assume the same 10% move in either direction occurs after earnings. Using the current deltas, if Visa beats earnings, the Call option contract will get to at least $460 while these deltas indicate the PUT contract will drop to about $0, which again is extremely unlikely. Now if Visa misses earnings and slides $6, using current deltas the PUT contract will increase to at least $340 while the call option decreases to $0.

Strangles are a bit cheaper, but even more dangerous, because if Visa does not pop or drop, and moves within the 57.50-62.50 range these contracts will certainly lose you money.

A major factor in making the decision will depend on where Visa is trading at 3 PM Wednesday. But straddling Visa is a much safer bet...

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