By Andrew Giovinazzi
Looking at the economic picture today, the market seems to like what it is seeing. Stocks are living with no growth in Europe while it restructures. Asia is still growing, and given the measures the Chinese have to go through to slow things down, growth will not end anytime soon. Both the fiscal cliff and the sequester became exercises in silliness by Congress and the White House.
The market is saying it likes smaller deficits (or near to it) and wants to see the path to balanced budgets. The flood of risk capital coming back from the sideline will pull things up.
I think part of the reason we are stuck over the past couple of days on decent data is the lack of reality from the Senate budget. They did pass a budget, but it seems stuck in 2009. Let see if any of this improves. I do think this budget negotiation will make U.S. equities stall for a bit. Since that is the pattern over the last year I don't see much to change it.
From a trade point of view, that makes me move away from the broader-market products, much like I did in the fourth quarter of 2012. Part of trading is following certain products and adding positions when they become interesting again.
If you followed my earlier column on Zynga /zigman2/quotes/209662259/composite ZNGA -4.15% you would be a happy camper. Essentially, the market was in tank when the fiscal cliff talks were raging. I thought it was useful to find a stock with not much downside left. ZNGA is now around $3.65 from $2.35, and just down from $4 on Tuesday. The initial risk reversal for .06 is worth .65, so that is a pretty nice return on both margin and risk. Now what to do with it?
If a stock is doing what you want, I view that as a good thing, but since the trade is up quite a bit, I would prefer to roll the risk out. There are a lot of dollars tied up in March and with expiration a couple days away, I would close out the March risk reversal and look for another.
I do like the fact that New Jersey is allowing Internet gaming, and ZNGA has a pretty large audience, so the potential there is enormous. It might not have been what Mr. Pincus had in mind, but the opportunity is soon to be there. So for me I want to roll but move the risk around a little.
The keys to these trades in the small-dollar stocks are to use margin but don't spend a bunch for the position. The big difference now and in November is the skew in the puts. In November, there were decent prices for selling puts vs. buying calls, and now the calls are actually bid up a bit. Possible takeover, etc., has pushed up the call prices, so you don't want to be hung with higher priced calls. So alter the trade a bit. Use the upside skew, and buy a call spread and finance most of it with a put sale.
In this example, the trade and ratio would look like this with ZNGA trading 3.66.
You could buy 1 ZNGA June 3.5/5 call spread for around .44
You could sell 1 ZNGA 3 put for .26 or around .18 in total debit.
If you want to reduce margin, you could buy the June 2 put for .03 or .04.
This will leave the trade around .18 in intrinsic value, which is .02 above the stock now but with an upside of 1.32 for the spread. That is not much risk really considering there is .60 or so already in the kitty. Even if you did not look at ZNGA before, I think this is a good way to approach a stock in the rumor mill that has some real upside.
Disclosure: Mr. Giovinazzi has positions in ZNGA.