AKS : Married Put with a twist

Today we initiated a new strategy using in the money (ITM) married puts over 6 months (or more) trading period. We chose AKS as these have underperformed (relative to the market) and potentially undervalued. We will play them from the long side for 2012, but will keep our maximum possible losses to around 10% for the next 6 months. If we are wrong we will live to fight another day.

AKS – AK Steel

AKS is a low margin steel producer, and a play on “the economy getting better”, however they do have large pension liabilities and thin margins. However if things get better then their earnings per share (purely on a percentage basis) could rise quickly, prompting more investment interest and driving the stock up quickly (it is heavily shorted, but when it moves it can move up 20%+ in a few trading sessions)). However it has to be recognised that there is some significant downside risk as the fundamentals are not that great.

If we are correct on AKS, we would be targetting initial resistance at $10 (Jan 25th 2012), then if that is broken then the next resistance is at $14 to $16 (from Feb 2011 to July 2011). This is obviously a lot of ground to make up in 6 months, and it is purely from a technical perspective.

Trade :

Long AKS 1700 * 8.08 (Feb 27th 2012 close price) = $13,736

Long 17 AKS Sept 2012 Puts strike $9 costing $1.78 = $3026

Total trade cost = $16,762

Risk :

Max risk (at expiration) : $9 put strike minus $1.78 put cost is $7.22. The stock was bought at $8.08 so maximum risk is (8.08 – 7.22 / 8.08) = 10.64%

Initial Trade Delta :

Position delta : stock (delta of 1 obviously), put option (delta of -0.56), so long delta 0.44

BTW – we are the only people interested in trading that option today as you can see from the daily option volume on Feb 27th 2012 (our 17 contracts was the only trade at that strike for that month).

Trading notes

Dont plan to leave the put option on all the way until expiration (due to time decay) – we will investigate if it worth rolling up or down every month (at monthly option expiration) while the trade is on. If we get to 3 months and no trade presented itself, we would probably roll up to another 6 month put (Dec 2012?) to avoid the battle with time decay in the last 3 months of the options life. A bad thing that can happen with this trade, is if the stock just moves around in a tight trading range for 6 months (but historically they have been somewhat volatile (AKS beta = 2.67) and hopefully this volatility will continue).

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