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OPTIONS TRADING


With CISG, Sell A Call, Ensure A Trade?

09/22/09 08:48:41 AM
by Donald W. Pendergast, Jr.

CNinsure, Inc., a growing force in China's property/casualty and life insurance industry group, has been performing well in recent months. Savvy traders may be able to squeeze even more profits, now that the stock has cleared a recent weekly swing high.

Security:   CISG
Position:   Buy

Continuing with the emerging markets/China equity opportunity theme, here's another look at an extremely strong stock, this one hailing from China's rapidly expanding financial services industry. Shares of CNinsure, Inc., (CISG), had a very bumpy ride from late 2007 into early 2009, but have done remarkably well after exploding upward from a pronounced flat-base breakout this past May. There may still be some opportunities for traders here even after such a major run higher, so let's hit CISG's weekly chart for a no-nonsense briefing (Figure 1).

FIGURE 1: CISG, WEEKLY. With a clean break above a significant weekly swing high, and with all key trend-confirmation tools saying to go long, putting on a November $22.50 covered call trade here looks like a good move.
Graphic provided by: MetaStock.
 
Figure 1 is the weekly graph for CISG, overlaid with a set of four-, nine-, and 18-period exponential moving averages (EMAs), an Aroon (14) indicator, weekly volume histogram, and the Metastock Profitunity (Bill Williams) expert advisor. The chart says it all: a major uptrend is in progress, one that should be given every benefit of the doubt. This massive uptrend kicked off in May 2009 when CISG finally broke out of an extremely long, extremely flat, low-volatility base, a breakout that was further confirmed when the four-week EMA crossed the nine-week EMA after both had already crossed the 18-week EMA. More recently, the widening spreads between the three EMAs helps to confirm the upward momentum of the trend, as does the vote of confidence from the Profitunity expert advisor (the green ribbon at bottom of chart).

At the top of the chart, note how the Aroon (14) indicator has just snapped higher, pegging its upper limit after a brief pullback. This tells us that the trend is back in full force for the time being. The most recent bullish development has been the break above the August 2009 swing high at $18.75, and that's really the key element that causes me to recommend a November 2009 covered call setup in this particular stock.

FIGURE 2: COVERED CALLS. By offering an annualized covered call rate of return in excess of 60%, the positive trending aspect of CISG shares help make these numbers even more appealing.
Graphic provided by: ThinkorSwim CISG call data.
 
Figure 2 shows the covered call annualized return for the CISG November 2009 $22.5 buy-write; it offers better than 63% annualized, which looks very attractive in a world of pitifully low interest rates. The bid-ask spread (on the right) is a bit wider than would otherwise be desired, but working a few limit orders and doing a little intraday timing could help that situation noticeably, for those who are determined to get a better price.

FIGURE 3: OPTION GREEKS. These Greeks ain't no freaks. You can currently earn $2 a day watching this call slowly expire; during the final 30 days before expiry, this amount will increase dramatically in relation to the price of the call option's value.
Graphic provided by: ThinkorSwim CISG call Greeks.
 
Figure 3 shows the option greeks for the $22.50 call; the delta is 0.55 and the gamma (the rate of change in the delta) comes in at 0.07 for every $1 move in CISG shares. Meanwhile, the call will shed about $2 per day in time value (with a theta reading of 0.02) and the vega (the implied volatility risk) is at 0.04, meaning that if the implied volatility of CISG jumps (falls) by one point, the $22.50 call option will increase (decrease) by $0.04. This is essentially telling you that the risk of having your position adversely affected by a rise in implied volatility is approximately 2 to 1. Another way of looking at it is, if a similar buy-write had a vega/theta ratio of 4 to 1, if would be considerably more risky -- from a rising implied volatility viewpoint, that is. Over time, you'll be able to better understand the ever-changing, dynamic relationships that exist among the option greeks that govern your option-related positions, and you'll be able to interpret what they say with a great deal of confidence, helping you drop losing positions quickly while staying with clear-cut winners.

Managing a position is of critical importance, and the best way to do that on this setup is to simply set an initial get-out point at last week's low -- $19.68. If the stock quickly turns and burns, taking out that low, then unwind the entire position, take a modest loss, and wait for a better opportunity. But if CISG keeps cranking higher, begin trailing it with a two-bar trailing channel stop of the weekly lows. This should give it plenty of room to back and fill a bit as the anticipated uptrend (hopefully) gets moving toward higher ground. At expiration, if CISG expires at $22.50 or above, the shares will be called away and you can put another check in the win column. If the stock fails to do that (and you haven't been stopped out), you get to keep the stock, perhaps selling another call against it if you desire. All in all, this looks like a low-risk covered call proposition worthy of consideration.



Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address: lineartradingsys@gmail.com

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