TWC Trade Update: Protect Your 55%-Plus Profit

Options provide us with many strategies to take advantage of changes in stock prices with more precision than simply buying or selling shares. One basic strategy known as a straddle involves buying both a call and a put at the same strike price and expiration date. This allows traders to profit from an impending breakout regardless of the direction of the move.

Because earnings reports can be catalysts for large directional moves in stocks, this is a strategy we like to employ ahead of announcements. Below is an example of a Time Warner Cable (NYSE: TWC) straddle from July 12:

TWC Chart

When the upward breakout was established, the losing put side was sold to lower the overall cost basis. The total cost of the original September $85 straddle was $5.80. If nothing happened and the stock sat at exactly $85 at expiration, both options would expire worthless and the maximum loss would be the premium paid.

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As I said, the put side was sold after earnings at $1.50 to lower the risk to $4.30. That reduced the expiration breakeven to $89.30 ($85 strike + $4.30 basis). The September option expires on the third Friday of September, leaving plenty of time for more bullish upside development.

With TWC making new highs on Tuesday at $91.74, the call option is now deep in the money. At the time of this writing, the $85 strike was trading at $6.75 for a 55%-plus gain in a month. 

Trade Management

With plenty of time for this strong trend to continue, it is important not to place a protective stop too close and get knocked out in the market fluctuations. For now, I recommend putting a stop-loss at the $4.30 basis cost to exit the shares only on a major pullback. The risk is therefore reduced to breakeven with over a month until expiration.