Strategy Recommendation: Sell HE Put Spreads
Carley Garner | Jan 15, 2020 04:25PM ET
The DeCarley Perspective: Strategy Recommendation, sell HE put spreads.
*There is a substantial risk of loss in trading futures and options.
* Past performance is not indicative of future resultsOn the radar:
Hog prices are low and Chinese demand could start to pick up. We like selling put spreads.
SELL DIAGONAL PUT SPREADS IN LEAN HOGS.
The seasonal low in hogs is due in the coming weeks and with the US/China trade deal set to be signed today, we could start seeing Chinese demand for US pork normalize. Even if it doesn't the US market has probably priced in a near worst-case demand scenario. Thus, we like playing the upside in a well-hedged manner using diagonal put spreads.
Specifically, selling the April lean hog 66.00 put and buying the February 60.00 put creates a strategy that stands to profit whether hogs trade higher, lower or sideways but will lose it prices decline dramatically. The spread can be sold for roughly $700 before considering transaction costs and comes with a margin requirement of just $495.
The risk and reward calculations are complicated by the fact that this trade involves options with two expiration dates. The short April 66.00 put expires in about 60 days while the protective long February 60.00 put expires in about 30 days. If both options were held to expiration, the max profit would be in the ballpark of $700 but that would require holding a naked short put for 60 days beyond the expiration of the February options. This isn't something we would recommend. However, if everything goes as planned we suspect we can buy the spread back in the coming weeks at a much lower price than the spread is being sold today. Our initial profit target for the spread will be $400. On the flip side, due to the difference in futures pricing the intrinsic risk on this spread is less than the 6.00 points between strike prices. In fact, because the April future is about 8.00 higher than February, there really isn't any intrinsic risk but we estimate that if things go wrong the risk could climb into the several hundred to one thousand dollar range.
Margin: $495
Delta: 0.11
Zaner360 symbols: OHEJ20 P66 and OHEG20 P60
*There is unlimited risk in naked option selling and futures!
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