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Goldman Sachs And The Short-Term Put Sale Op

06/30/10 08:55:17 AM
by Donald W. Pendergast, Jr.

With the broad markets finding short-term support over the last two sessions, now may be the time to consider selling near-term, out-of-the-money puts on Goldman Sachs shares.

Security:   GS
Position:   N/A

Goldman Sachs (GS) common shares increased by more than 300% between November 21, 2008, and October 14, 2010, before reversing direction as the stock underwent noticeable distribution (the transfer of shares from strong hands to weak ones) for three and a half months. The stock then made another attempt at the October 2009 high, fell short, and then sold off with a vengeance on ultrahigh volume (the biggest daily selloff bar since the two consecutive daily selloffs in mid-September 2008), continuing to fall until just this past week. Can the once-mighty GS regain some of its former glory, or is this latest surge higher just a flash in the pan? Let's take a closer look (Figure 1).

FIGURE 1: GS, DAILY. Although this may not qualify as a major trend reversal, the technical evidence still seems to support a minor bounce higher, perhaps as far as the early June high at $146.40.
Graphic provided by: MetaStock.
Graphic provided by: Rahul Mohindar (RMO) indicators from MetaStock v.1.
First, this is intended as a short-term trade and one that should probably be exited after a few more days of favorable price action in this stock. The overall state of the broad market internals is still very bearish, so keep that in mind if you are playing any moves to the long side over the next week or so. With that disclaimer out of the way, what we see on the daily GS chart is supportive of a minor bullish bounce, one that may take the stock up toward the last minor swing high at $146.40 (made on June 1, 2010). Note the bullish divergence of the short-term money flow with the price action over the past few weeks; it's finally begun to resolve with the bullish action on the chart. Next, witness the new RMO (Rahul Mohindar oscillator) swing buy signal (green arrow on chart), one that comes shortly after a successful, albeit minor test of support near the $132–133 level. The daily bar has pretty decent range, but the volume isn't particularly exceptional. Nevertheless, this appears to be a valid break higher from a short-term support level. Even in bear markets, stocks can sometimes stage unexpectedly strong rallies, so perhaps there is a way to play this anticipated bounce by way of the option market.

FIGURE 2: GS PUT. Goldman Sachs equity options feature excellent bid-ask spreads, volume and open interest. The highlighted July 2010 $125 put is a good example.
Graphic provided by: Thinkorswim.
Given the tentative support area described, here is a fairly low risk short-term put sale for those convinced of a short-term Goldman Sachs surge.

Sell 1 July 2010 GS $125 put option
Net credit: $0.85 or better

This particular put has a very close bid-ask spread, good volume, and open interest, too (Figure 2). The option also features a low delta (-0.12), meaning that it currently has a low probability of expiring in-the-money at July option expiration (18 days from now). With about $7 of cushion between the put's strike price and the support at $132, this looks like a good strike to sell, especially if you want to take potential profits quickly should they appear. More conservative traders might consider selling the July $120 put instead; it offers more staying power on a temporary adverse move back toward support and is currently offering about $0.55 in premiums for option sellers.

The next resistance in GS is at $146.40; if the stock makes a quick move to that price level after you've sold your puts, consider taking at least half of your position off at that point. You may also want to slowly trail the open position, making sure that you cover all remaining short puts if the $131 is violated on the downside. And by no means ever let the option double in price before buying it back for a loss; doing so will help limit your losses and keep things under control.

Bottom line: expect a minor bounce in GS shares this week. Those who sell either the July $120 or $125 put at or near the current bid price stand to make some quick profits on an anticipated runup toward resistance at $146.40. Those selling the July $125 put for $0.85 stand to make about $80 in profits if GS moves up to $146.40 by July 7, 2010. Conversely, should GS fall to $130 by the same date, the loss per contract will be about (-$80). However, don't count on any extended move past that resistance level without some major bullish fireworks across the entire stock market. This particular trade is strictly short term, so be sure you monitor it closely.

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:

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