Market Summary for the Option Trader
MARKET SUMMARY – MAY 2008
By: Marcelo Tames
EXAMPLE ON HOW OPTIONS CAN LEAD YOU TO A QUICK FORTUNE: What did really happen with Ericsson´s shares in the last seven months?
The shares of the Swedish, blue-chip company Ericsson have had moments of great volatility (as many others) during the last seven months, which could have lead to huge profits if you had have foreseen what happened. This situation leads to greater risks for stock traders thus a safer and perhaps more effective (if done correctly) way to hedge are Options . For example, on April 25 th , option traders had one of those unforgettable days since the Sweden based company Ericsson presented better than forecasted results for the first quarter in 2008.
Ericsson in Sweden is one of those called “people´s shares”, a Swede who doesn´t have at least a small part of Ericsson in his/her portfolio is not a Swede at all. Nonetheless, Ericsson stock price has had an unfortunate development for the last seven months. Everything started on October 15 th when the stock price went down by 25% after the CEO Carl-Eric Svanberg warned for lower earnings than estimated. The day before Ericsson shares were trading at a level of 26.5 SEK (Swedish krona) per share ($ 1 
6 SEK) and from that date the price has been decreasing in a negative trend supported by a bear market which had been born by a current recession in the United States. The lowest point was achieved on March 19 th when a share cost just 10.05 SEK, which implies a decrease of 62% since the first warning. It´s obvious to deduct that those bearish option traders had a great time in that period since by just buying put options on different prices, they could have had an almost sure profit after some time. So if somebody missed that opportunity, the question was then how to find the new ones. From that low point, Ericsson has climbed 50% to above 15 SEK per share and the shares surged specially on April 25 th on a better than expected first-quarter results.
To understand the option trading mechanism and its potential, let´s analyze how you would have made a great deal of money in the last event. On April 24 TH , the closing price of Ericsson shares was 12.44 SEK and the call option for Ericsson with strike price of 16 SEK expiring in June (ERICB8F16) cost 3 öre (0.03 SEK) and the next day rose the price jumped to 0.80 SEK (an increase of 2567%!), just in one day. Imagine investing just $1000 one day and the next appear having more than $ 25000, but you would say that it was too risky since Ericsson has been in a negative trend. It is then when a good Option Strategy can fit you and insure you in case you are wrong.
First things first, define you position. Are you bullish or bearish on the stock price development? If you thought it could go up but didn´t want to risk too much then you could have built a bull spread strategy to limit your possible loss and profit. Consider buying ERICB8E15 (call option for Ericsson with strike price of 15 SEK expiring in May) for 0.02 SEK and selling the same amount of ERICB8F16 mentioned in the previous paragraph at the same time for 0.03. You would have even had started +0.01 SEK in that strategy and in the report day, you would have made a profit of 2750% in your ERICB8E15 (it cost 0.57 SEK) but at the same time lost -2567% ERICB8F16. But since you were in the right side, you would make +183% (2750-2567) on that strategy + the extra 0.01 SEK from the beginning.
In the volatile market that we live now, holding stocks for a long time seems not to be a good idea and the money is in trading this time. Therefore if one wants a less risky strategy, then and option portfolio can lead to a hedged position and higher profit margins.