Jocelynn Drake (jdrake@sir-inc.com)
8/30/2006 11:56:16 AM
Today, I want to look back at a trade on E*TRADE Financial (ET) in our Leverage Series.
In case you're unfamiliar with the company, E*TRADE Financial
(ET:
sentiment,
chart,
options)
is a top online brokerage, with more than 3.5 million account holders who can trade stocks over the Internet (the majority of transactions) and by phone. The company also offers online and retail banking, mutual funds, market making, and stock plan administration services. The majority of the company's business is in North America. However, the firm is attempting to tap international markets through retail brokerage web sites in about 10 countries in Europe, Australia, and the Pacific Rim.
When we recommended a put position on the stock in mid-May, the shares were starting to break down. The equity had recently lost of the support of its 10-day and 20-day moving averages. These short-term trendlines had helped to usher the security higher and we were now expecting them to act as a layer of resistance.
What's more, the stock had also breached its 20-week trendline, which had served as flawless support since June 2005.
Adding to ET's struggles, the security was even facing potential options-related resistance. The stock has slipped below the 25 strike, which was the site of peak call open interest in the June and July series. As we have seen in the past, a hefty accumulation of out-of-the-money call open interest will frequently serve as resistance.
Meanwhile, investors were unwilling to believe that the company's uptrend had finally come to an end. Short sellers were still avoiding the company, as less than 2.5 percent of ET's float was sold short. Furthermore, it would have taken less than 2.5 days to buy back ET's shorted shares at its average daily trading volume. This paltry accumulation left the security little in the way of short-covering support to help boost the shares.
Wall Street was also smitten with the company. According to Zacks, five of the nine analysts following the online brokerage firm rated it a "buy" or better. Any downgrades from this optimistic group could spell trouble for the security.
With this combination of growing weakness and lingering pessimism, we believe that the equity was primed for continued losses. So, on May 17, we recommended subscribers of our Leverage Alert service purchase the ET July 25 put at a maximum entry price of 1.90.
What happened with the trade, you ask.
The stock continued its downtrend under resistance not only from its 10-day and 20-day moving averages, but the equity remained capped by its descending 10-week moving average. On June 12, we advised subscribers to one-quarter of their put position to lock in an average profit of 77.8 percent. By closing only a portion of the position, investors were able to protect some of the profits they had already earned on the position in the event that the stock bounced back.
But ET didn't bounce back just yet. On June 14, subscribers were advised to close a second quarter of the original position to lock in an average profit of more than 223.3 percent. From there, ET clawed its way slightly higher from its June 14 low. However, we continued to hold onto the position to see if the shares would dip lower again. While the shares remained capped by their 10-week trendline, they never returned to their previous near-term low. The final one-half of the position was closed out on July 21 just ahead of expiration for an average profit of 66.3 percent. Sure, it's not quite as nice as the 223-percent gain, but by taking out partial positions on the put, investors were able to lock in an average gain of 108 percent.
Furthermore, the leverage that options offer traders enables them to not only risk less money on a position, but also rake in larger gains than if he/she had bought only the stock. When we opened the put position, the stock was trading at $24.01. At its June 14 low, the shares had lost less than 22 percent, yet put holders were able to lock in a partial gain that day of 223 percent. Furthermore, on July 21, the stock closed at $21.95, a decline of roughly 8.6 percent from its original trading price on May 17. Meanwhile, the final half of the trade was closed for a gain of 66 percent that day. A nice profit compared to selling the shares short.
If taking advantage of opportunities like the one detailed above appeals to you, check out our Schaeffer's Leverage Series. What's more, if you sign-up now, you can try it free for 30 days. For more information on this real-time alert service, please click here.
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