End Of Day Post

The markets continued to move higher this week, now fueled from favorable earnings results. We did see a strong bounce off of support, as the U.S. markets shook off the overseas move rather quickly. The continuation of this move, though, should be driven by earnings results moving forward.

Earnings season is still in the early stages, but we have seen some decent numbers in a few of the larger companies up to this point. So far...so good, although we still have a way to go before this round of earnings is complete and the overall results impact sentiment.

We have been talking a lot about sector rotation. With the passing of each earnings season, will need to identify any changes in sector trend. Pay attention to earnings results, especially with each sector, when adding new positions at these levels.

Technically, the markets are moving right back up to high resistance levels and are now showing signs of increasing volume. The VIX is dropping as fast as the markets are moving to the upside, as it currently revisits yearly lows.

Adding longer-term, bullish positions (preferably diagonals) at these levels would make sense; however, earnings season can pose a problem. If you are planning on taking longer-term positions, then make sure to trade outside of the earnings event, either before or after the results are posted. It is okay to wait until after the event to enter the trade, thus giving you a better idea of the stock's next move and increasing your probability in direction.

July monthly option expiration is tomorrow, so make sure to address your portfolios. Keep in mind your exposure moving into August and make note of any moves that need to be made going into next week. The markets appear to be strong here, so take your time and follow earnings results.

Mid-Week Outlook

• Bullish: 9%
• Sideways: 61%
• Bearish: 30%

Have a great night,

The Maverick Trading Team

End Of Day Post

Lower support levels held as the markets continued higher from last week. The S&P broke below its 2,080 support level last week, but bounced off of 2,050, and is still moving higher. Although the last few days have been bullish, we are now retesting minor resistance levels set back on June 11th. Volume is still on the lighter side, but the movement is definitely bullish, as we have seen a decent drop in the VIX over the last couple of trading days.

We need to stay cautious as this could still be a very large bear rally to this point. We haven’t seen an answer from the bears yet, but expect one later this week. Entering new trades here will be difficult with July monthly expiration coming up, along with the amount of volatility that we have seen in the markets the last few days. Consider staying balanced if you are going to enter longer-term positions here. Trying to gauge shorter-term direction will prove difficult until the week progresses.

Another earnings season is upon us, so make sure to keep track of earnings dates and/or earnings results of any stocks on your watch lists. Earnings results can create sector rotation, so keep an eye on sector performance over the next few weeks.

Have a great night,

The Maverick Trading Team

LEAPS and Mergers

From Our E-mail Archives: We received a question about the effect of mergers on LEAPS options. Our Head Trader, Robb Reinhold, answered the question, plus described the concept of merger arbitrage.*


-----Original Message-----

From: Colin M.

Subject: LEAPS and Take-Over Price Target

Hi Robb,

Say you own 2016 LEAPS (Long-term Equity AnticiPation Securities) in Heinz (Ticker: KHC) at $60 and Warren Buffet decides to come in and acquire Heinz privately at $62.50 tomorrow.

Would your LEAPS immediately lose all of their extrinsic value and drop to $2.50 in value? Do LEAPS still retain some of their extrinsic value when the underlying stock is taken private?

Thank you,
Colin


-----Reply Message-----

Hi Colin,

Technically speaking, if that scenario happened, then the Implied Vol (Volatility) and Time Value would go to almost zero immediately. However, in real life, that never happens. Even after the announcement of a merger, the prices don't change automatically since the actual merger or buyout is typically months away and each company has to go through a process of possible regulatory approval, shareholder approval, integration questions, etc.

So, there will still be at least a month or two before the actual merger happens. During this time, there is an entire trading strategy called merger arbitrage, where traders will take positions based on the likelihood of the deal closing or not.

For example, let's say the Heinz buyout is announced at $62.50. The first thing to determine is if the offer is all cash, half cash/half stock or an all stock deal. If there is stock involved, then there is now the underlying risk of the acquiring company's stock going down, so this will be built into the market price and Heinz might only trade at $61.50 on the day of the announcement.

If traders think that there may be big regulatory or shareholder hurdles, then the price of Heinz might only be $58 due to the risk of the deal not closing. On the other end of the spectrum, I have even seen stocks trade above their buyout price if traders think that a competing, higher bid might come in for the stock.

Due to all this uncertainty, there will still be extrinsic value built into the options. The less likely that the deal will get done will equal a greater extrinsic value. However, as the stock gets closer to the actual buyout date and hurdles are removed, the risk premium comes out of the stock where it will move up to 61.40 or higher and the risk premium will leave the options as well.

Hope this helps and have a great weekend,
Robb

* NOTE: Some original wording has been slightly modified for legibility. Also, stop using ketchup on your hot dogs. You're too old for that. Use a spicy mustard instead.

End of Day Post

The markets closed slightly higher after the third day in a row of wide-range trading. The S&P and Dow closed below their respective 200-day simple moving averages for the second day in a row. The Nasdaq gapped higher on its open, then steadily gave back nearly all of its gains, though it still ended up for the day.

The markets are still waiting to see what is going to happen with Greece and China. On some positive news (though it may be short-lived), China introduced new market support measures, leading the Shanghai Composite to have its best day (up nearly 6%) in the last six years.

As we near the weekend, we will continue to closely watch how the U.S. markets continue to deal with the uncertainty surrounding Greece and China. So far, we just have not seen the bullish catalyst that we need to have the markets head higher with conviction.

Trade cautiously and think about letting trades come to you.

Have a great night,

The Maverick Trading Team

End of Day Post

The markets made a remarkable recovery today after being down over 1% mid-session. The S&P temporarily broke its 200-day simple moving average for the first time since October 2014. The Dow and Nasdaq hit their lowest intra-day prices since February and May, respectively.

Eurozone officials are saying that Greece "might" submit a new aid proposal to European creditors tomorrow (Wednesday). However, any new proposal is not likely to differ significantly from prior proposals, which could add more hesitation in the markets. As price action is often an indicator of "yet to be released news," we believe that Greece and the eurozone took a major step toward a resolution today.

We will watch closely how the U.S. markets continue to deal with the uncertainty surrounding Greece. Expanded range bullish candle reversal patterns have been found at many of the important bottoming points in the broad markets over the past few years. So, today's reversal should be respected at a minimum, if not acted upon!

When a big expanded range candle forms, the next day is usually a harami (inside day). So, tomorrow may give an opportunity to buy on a very minor intra-day dip if you didn't already pounce on the bullish reversal in today's session.

Have a great night,

The Maverick Trading Team

Getting Exercised

Today, our Head of Trader Development, Joe Jensen, answers a question from one of Maverick's traders about getting exercised in a position.*


-----Original Message-----

From: Chris T.
Subject: Getting exercised

Hi Joe,

I have a really quick question for you. I'm in a really nice bull call spread with Goldman Sachs right now and it got me thinking. I've always had it as part of my plan that if the price per share hits my short, then I would exit the position – which is fine if it is the week of expiration. However, in this case it is a June spread. So, if it hits the short this week or next, then (by following my plan) the profit will be about 1/3 of what the max gain would be.

I thought about why I have that in my plan and I realized it's due to a fear of getting exercised. I now have a couple questions about it:

1. Do options get exercised often prior to the expiration date or does that never happen?
2. Also, if I'm in a spread and they exercise, will Interactive Brokers (IB) just exercise my long and the trade is over? If that's the case, then I really shouldn't have any fear of it and can change that part of the plan instead of exiting immediately because I feel like I might be leaving money on the table.

Thanks in advance for any advice.

Regards,
Chris


-----Reply Message-----

Hey Chris,

This is a great question and one that I get often. Getting exercised (i.e., assigned stock) in an option position can be extremely unnerving, especially when you see the amount of margin used and the unrealized profit/loss. There is no real way to tell if you will get exercised. However if you find yourself deep in-the-money (ITM), then the odds do increase.

Remember, options are priced based on two things:

1. The amount of intrinsic value (how much an option is in-the-money)
2. Plus, the amount of extrinsic value (time and volatility remaining in the option).

If the holder of an option was to exercise his option and convert it into stock, then he has wasted the time value. People don’t like to throw money down the drain, though, so that's why options aren't usually exercised early.

For example: ABC is trading at $52/share and a trader owns the 50-strike calls worth 3.00 each. Each option has 2.00 of intrinsic value and 1.00 of extrinsic value. If the trader exercises the option early, then he is actually throwing 1.00 away per option since they will own stock at $50 that is worth $52. They have only 2.00 of value by exercising instead of the total 3.00 of value that the option was worth. Thus, if a trader really wants to own a stock instead of an option, he will dump the calls and simply buy the stock in its place 99% of the time.

Usually, options are exercised near their expiration and only if a dividend is involved. The reason is simply that if the dividend is worth more than the extrinsic value, then it makes sense to exercise the calls early.

If you ever get exercised, it is important to remember to trust in your combo. Vertical spreads are hedged, so take a look at the risk graph and you will see a max gain and max loss point. Even with a stock assignment, you are still hedged due to your other leg in the combo. Essentially, you are still in the same trade...it is just that the stock was substituted for one of the option legs.

If you are ever assigned stock, take a look at the stock chart to see if the combo is still favorable. You can always close this position manually by getting rid of the stock first and then selling the other option. If the combo is ITM (which it probably would be due to the assignment), then you can let the whole thing expire (same day substitution), which would equate to a max gain if you bought the debit spread.

This isn't exactly true for all combos, but if you are in any "combo," then you will be hedged up to a point. Always refer to your risk graphs for help and make sure to add a plan of attack for assignment in your trading plan.

I hope this helps,
Joe


* NOTE: Some original wording has been slightly modified for legibility. Also, the original response was modified to add additional content, including an example.

End Of Day Post

The markets finished flat on today’s session as we enter into the July 4th holiday. Since Monday’s sell-off, the markets have been floating higher, but with decreasing volume. This was to be expected going into the long holiday weekend. Even though the markets managed to move off of Monday's close, this still feels like a bear rally here.

With the U.S. markets closed tomorrow, the focus will move to Sunday’s Greek bailout vote. No matter the outcome, it will definitely have an impact on Monday’s U.S. session. Make sure to allow the volatility to settle down a bit before entering new positions.

The results of this vote could create a longer-term market sentiment change; however, Monday’s reaction alone won’t be enough to determine that. We will need to look more towards Tuesday and Wednesday for follow through.

Stay patient on Monday. Entering later in the week can give us a better perspective on market direction, along with better pricing in our options with lower volatility. We will see if the Greek vote moves us out of this range or right back into it.

Mid-Week Outlook

• Bullish: 15%
• Sideways: 55%
• Bearish: 30%

Have a great weekend,

The Maverick Trading Team