Ford Motor (NYSE:F)remains in solid recovery mode judging by its latest earnings figures announced earlier this week. In the third quarter, F earned 48 cents per share, 10 cents better than analysts were expecting and 22 cents better than the year-ago period. Revenue, however, fell 4.3% year-over-year (but grew by $1.7 billion if the Volvo brand is excluded). After an initial drop out of the gate, Ford shares quickly recovered, closing up 1.5% in Tuesday's trading.
The day after earnings hit the Street, analysts with UBS upped their 12-month price target on Ford to $18 from $16, reflecting nearly 30% in additional upside from current levels. The firm adjusted its target based on the company's proven ability to expand its market share with new products. According to Briefing, UBS also feels Ford will improve its balance sheets in such a way that the company could be at a net cash position by the end of the year.
F shares have nearly doubled in value in the past year and have come quite a long way from two years ago, when the stock was trading in penny-stock territory. But do the shares have the strength to continue "motoring" higher? If so, for how long? Investors who are long in Ford may be looking for ways to hedge their positions or explore an alternative option to being just long the stock. Ford pessimists, on the other hand, could be on the hunt for bearishly-slanted strategies that don't require short-selling the stock.
We've outlined a pair of option strategies below – one bullish, one bearish. These strategies are for educational purposes only; consider your own goals, risk tolerance, and experience before executing any new trades. All prices are as of Wednesday's close, when F shares were at $14.23, down 13 cents (0.9%) on the day.
Bullish Option Strategy: LEAPS Diagonal Call Spread
Investors who expect Ford's upward momentum to continue could consider a diagonal call spread, which combines some qualities of a time spread with a vertical spread. For example, a trader could buy the January 2012 10-strike LEAPS calls for $4.90 and simultaneously sell the shorter-dated January 2011 15-strike calls for 60 cents each. Essentially, selling the shorter-dated position helps offset some of the cost of the LEAPS call.
If the traders remain bullish in Ford through January 2011 expiration but the 15-strike calls expire worthless, the trader could sell another shorter-dated call, perhaps with a June 2011 expiry, to further offset the purchase price of the original LEAPS call. If Ford shares are higher than $15 as the first expiration date approaches, the trader could opt to roll the short in-the-money calls up and out to a later month (again, perhaps June 2011), collecting additional credit to once more offset the initial cost of the 10-strike option.
If the investor chooses not to roll the short call, maximum loss at January 2011 expiration is limited to $4.30, or the difference in premiums. However at the first expiration, the long January 2012 option will have one year remaining until expiration and will almost assuredly have substantial time value left.
This process requires careful position management but can ultimately mean exposure to a longer-dated long call for a reduced premium price. For the long call, gains are theoretically unlimited and losses are capped at 100% of the premium paid (less any credit collected from selling short calls). Note the caveat that the declaration of a dividend could have a negative impact on the theoretical value of the LEAPS call.
If you would like to experiment with how changes in stock value, implied volatility, and time until expiration could impact the value of this strategy, I would recommend using a profit/loss calculator. The OptionsHouse platform has a user-friendly calculator tool available as part of a free virtual options trading account.
Bearish Option Strategy: Put Ratio Spread
Ford skeptics could consider a put ratio spread by shorting two out-of-the-money puts and buying one near-the-money put. For example, a Ford bear could buy one January 14 put and sell two January 12 puts at the same time, paying a net debit of 36 cents per spread.
At expiration, the potential profit is capped at $1.64 per spread if Ford is trading right at the short strike (12) when the options expire. Profit is limited to the difference between strikes less the debit paid. This provides a limited downside hedge of about 15% down to the 12 strike.
Breakevens for this ratio spread are $13.64 (the long strike minus the debit paid) below which the spread is profitable and again at $10.36 (the short strike minus the maximum potential profit) to the way downside. If F shares are trading between these levels at expiration, the ratio spread will be profitable.
If Ford remains above the $14 level, the maximum upside risk is capped at the 36-cent premium paid. Downside risk is significant because of the uncovered short put that is in-the-money below the 12 strike. If Ford moves dramatically lower, losses can be substantial, in line with a long stock position.
Earlier this month (on the heels of Morgan Stanley's new "overweight" rating on Ford), our bulls/bears column discussed a split-strike synthetic long position for the bulls (short the March 12 put and long March 14 call for a credit of 11 cents). On the bear side, we outlined the November 13/12 bear put spread, bought for a net debit of 38 cents. The synthetic long could now be closed at a credit of 90 cents for a $1.01 profit and the bear put spread is worth roughly five cents, incurring a loss of $0.33. The stock has gained $1.39, or nearly 11%, during this time period.
Please refer to Characteristics and Risks of Standardized Options, copies of which can also be obtained by contacting our Customer Service Department firstname.lastname@example.org.