RIMM and CME are far enough away from their strikes that the intrinsic value in the options make their probability low.  Have to look tomorrow where the straddle is if they get near the strike.  The BIDU and MA straddles look under priced.

Minnesota Mining & Manufacturing

A steady conglomerate paying steady dividends. So 29th October I thought it would pay its dividend around the 19th of November, like last year. So I bought some stock at 75.24 and sold the Nov 75 call for 1.8 giving about 2.4% of downside protection. The beta of MMM is 0.8 so you could say that we have about 3% downside protection on the S&P 500.

There was 0.24 of intrinsic value and the rest, 1.56 time value in the call.

Usually MMM announces the dividend eight to nine days before the ex-dividend date and it hasn’t announced yet.

Today, MMM was trading near 78.75 and the call at 3.9, 3.75 in the money. My return would be 1.41, so I took off the trade. My reasoning was, if the ex-date is before November options expiration, and the stock is called, I would earn another fifteen cents, but I would have to wait about nine days. If MMM dropped enough so that it wouldn’t be called, I would get the 51 cents dividend if the ex-date is before expiration.

Didn’t seem worth waiting for. What do you think? Comment below.

Most of the straddles are fairly priced. MA and GS and CME look like possibilities.  The last column is the probability to exceed either break even point, stock + straddle and stock – straddle value.

Australia: +1.25%

Nikkei 225 (Japan): +0.55%

Europe at mid-day:

FTSE 100 (UK): +0.80% at 10:30 AM

DAX (Germany): +0.82% at 11:52 PM

CAC 40 (France): +0.75% at 11:52 PM

European markets are up steadily since their open.

SPY after hours: +1.0% at 6:10 AM

QQQQ after hours: +1.0% at 6:11 AM

light volume for SPY and QQQQ after hours.

Economic Indicators: Building permits filed and housing starts for June, are announced at 8:29 AM EST. This is expected to be flat compared to May.

Before the market opens: GE and Mattel (MAT), toymaker of Barbie and Ken, and BB&T (BBT) a large regional bank, announce earnings.

During the day: Bank of America (BAC) and Citigroup (C) discuss earnings.

Should be an interesting options expiration day.

The SPX weekly is settled Friday morning, this week it will be Thursday morning.  So the last day to trade it is usually Thursday, this week it is today.  The OEX weekly is settled Friday afternoon.

Dan Pasarelli talks about the advantage of buying the weeklies for option buyers, I don’t see it, but since time decay is fastest in the last week, it does make sense to sell the weeklies.

Disclosure: I am short the SPX 950 C and SPX 875  P expiring tomorrow.

I don’t know.

I like to think as far forward as options expiration, next one is 20th June.   What is my best guess of what might happen until then and how can I make a few profitable trades.

I deeply respect people who can buy GE now and wait patiently for the economy to improve and GE to clean up its balance sheet and grow all its businesses.  I can’t do it.

My last boss at Millennium used to talk to floor brokers all the time and ask them, Why is the market up?  Why is it down?  The stories they told him satisfied him.  “Soros has split a large order among five brokers and it is getting executed …”  Something like that.

Trading shows how well aligned I am with reality.  I like models and finding and testing a trading strategy.  But all trading strategies bother me.  What is left out?  What are the hidden factors that are really driving the profit in the strategy?

In an up or sideways  market, you can do really well selling puts.   It is simple, and with a little technical analysis and no news to move the stock, like earnings, you can get some comfort that the put will expire worthless.  Also, you can use an options calculator to calculate the probability of success  based on the historical volatility.   That is comforting too.

In a down market selling puts will kill you.  So you have to know the difference short term, until the next expiration.

The biotech industry has many product events.  What I mean by that is, investors wait for the companies to give results of tests of drugs that the companies are developing.  Or after the tests are completed there is one panel of experts that decides if the drugs are safe  and another panel votes on the effectiveness of the drugs.  These committee decisions are then passed onto the Food and Drug Administration (FDA) and the FDA decides whether to approve the drug for use or not.

Dendreon

If a drug is approved that is a windfall for the company, which is why biotech stocks trade like lottery tickets.  Dendreon has one drug, Provenge, ending a phase III trial at the end of April.  The drug is being tested to see if it can help men with prostate cancer live longer.   DNDN also has four other drugs in development.

My son did some research on Dendreon (DNDN) so that we could understand the process a little better.  DNDN lost $8.8 million for the quarter ending 31 December 2008.  In the fourth quarter of 2007, the company lost $26.9 million.  For fiscal year 2008, the company lost $71.6 million.  At the end of the year the company had $108 million on hand.

On 11th March, DNDN changed hands at $2.77 per share.  The day after the company announced earnings, on 13th March, the stock rose to $4.05.  Yesterday, it closed at $6.30  So there are believers out there.

At the end of March 2007, the evaluation by the FDA Advisory Committee (independent experts) voted 17-0 vote in favor of its safety and 13-4 in favor of its substantial efficacy.  But the FDA didn’t approve it.  The trials didn’t meet their stated goals.   One problem was that the number of patients enrolled was small and there were issues with the methods of the study.

So the FDA told the company to try again.

The company set up a larger test a year ago, March 2008 and announced interim results last October.  The independent data monitoring committee (IDMC) reported the interim results of the most recent Phase III trial to Dendreon. A 20 percent reduction in the risk of death in the PROVENGE arm relative to placebo.

Hazard Ratio

The hazard ration is an estimate of the treatment effect in the treated versus the control group in a trial.  The hazard ratio reported means that a PROVENGE patient who at the time of the interim analysis has 0.80 times the chance of dying compared to someone in the placebo group.  Its reciprocal, 1.25, means a placebo patient has 1.25 times the chance of dying compared to someone in the PROVENGE group.

This looks promising, but is still short of its proposed endpoint results which was 22%  reduction in the risk of death.

DNDN Options

A week ago, the April options had an implied volatility of 300%.  The straddle at the $5 strike was worth $5 which means that if you sold the straddle and the stock went to zero or ten dollars one would still break even.   I was so focused on the announcement at the end of April that I missed the opportunity here.

Since the April options expire next Saturday,  the 18th of April, nothing much would happen in these two weeks.  So selling such a high implied volatility would have been a good trade.  The stock is unlikely to move any where near as much as the implied volatility reflects.

On the other hand, trading the collapse of volatility in the May options, which covers the announcement period, is much more dangerous.   If the trials go well, the stock could double again.

Jeff Augen describes the dynamics of options expiration in his new book Trading Options at Expiration: Strategies and Models for Winning the Endgame.   It is 140 pages describing the dynamics of the last few days in the life of equity options. The three forces that drive the dying days of options are time decay, the collapse of implied volatility, and pinning of the stock price to strikes.

Time Decay

The weekend before the Friday that options expire is 36% of the time to expiration. That leads to strategies for taking advantage of that time decay. Thursday night before Friday expiration is another 17 hour period of time decay that traders take advantage of.

Pinning

I have written about pinning of stocks to strike prices before. In this book Augen uses tick data to show how selected stocks behave and migrate from strike to strike, if they are not pinned at one strike.

Volatility Collapse

There is an interplay between time decay and volatility collapse that Augen discusses. On the last day, as the ringing of the closing bell approaches, implied volatility of the options collapses.

Trades

Throughout the book, Augen uses examples of trades to describe what he believes are good trade structures and poor trade structures. He looks tick by tick at how the trade progresses through the day.

Go to Amazon and read other comments on Trading Options at Expiration: Strategies and Models for Winning the Endgame. I found it very interesting.

Evidence shows that there is clustering of stock prices around strikes on expiration Friday for stocks with options but no evidence that it happens for stocks without options or on other Fridays where there is no expiration.

The stock doesn’t move much from the Thursday before, today. So we can look after the close tonight and see which stocks are close to a strike and keep an eye on those to see if they get pinned at the open of trading Friday.

How Stocks Get Pinned

The evidence shows that pinning happens and that it is related to options expiration. How does it happen?

Public traders generally don’t delta hedge their positions while market makers do. So say Baidu is trading at 137, which it is now. Holders of the 135 calls are in the money and will be assigned stock on Saturday. If they do not want the stock, they will sell their options tomorrow for a nice profit. Market makers will buy the options, that is their job. To hedge out their exposure to price movements, they will sell stock. That way, if the stock moves up the call value moves up and the value of the short stock position moves down. They are delta neutral. This selling of stock moves Baidu’s price down towards the 135 strike.

Public holders of the 140 puts who do not want to deliver stock can sell their puts to the market makers who will buy stock to inoculate their position. This will tend to move the price up. This is more likely to have an effect if Baidu is fluctuating around 135 tomorrow. The buying and selling around 135 will tend to push it and pin it to 135.

The Trade

So if in the morning we see that one of these expensive stocks is getting pinned near a strike, we can sell a strangle that expires Saturday.

Check out: for a free CD with more high probability options income strategies

Options In The Money

The market is down over 2% at the open.  We’ll see where it closes.  McDonald’s and UPS are very near the strike so if Thursday and Friday are up days, the options could expire worthless.  Any way, there won’t be much of a loss since they are close to the strike.  Walmart is 5.4% away from the strike, near 52 with the strike at 55, and Verizon is about 4.5% (31) below the strike (32.5).  not so bad.

This option series only Schlumberger and Phillip Morris options closed out before expiration.

It has been a good down week, so I placed an order to sell 6 South Korea ETF put options with a strike of 26 at 1.9 or better.  Market is down nearly 4% at 11 AM  and I have been filled.

2:25 PM the market is down 3% and I will be put Coke too.  But maybe not.  It is close to the strike.

After the close:  Exxon Mobil is in the money, Coke is not.  We’ll see what tomorrow brings.