Wednesday, March 23, 2011

Xerox options play for earnings

As Xerox dipped back towards $10 today, I used options to control a third lot of Xerox shares. Specifically sold May $9 puts and bought May $11 calls for less than a penny per share out of pocket.

Earnings are scheduled for the April 18 so the May options will be impacted by this catalyst. I continue to believe (ok...hope) that they will confirm over $1 in earning per share for the year and this continues to be a value play, but here are the likely scenarios.

1). Worse case the stock looses 10% from here (below $9) over the next 2 months and falls below $9 in which case the portfolio will is committed to own a third lot. Per Yahoo finance book value is $8.59 so a $9 entry price seems like a prudent risk.

2). The stock stalls between $9 and $10 for two months in which case these options will expire with no impact on the portfolio.

3). The stock runs up. In theory if it spikes to its 52 week high of $12 that would be a $1 gain on the $9 in risk capital or 11% gain in 2 months. However, if earnings announcements are positive or market conditions improve there would be an opportunity to manage this position to reduce the risk by cover the short option and perhaps rolling the long option to keep the positive leverage in the trade.

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