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How to Play Transocean (RIG) via OptionTrading

Published on June 22, 2010

How to Play Transocean (RIG) via OptionTrading

June 22, 2010

How to play elevated Implied Volatility on Transocean (RIG), was a key question in lot of trader’s mind. In fact, it still is. This post is about one of the option + stock trading strategy that can be employed to play such scenarios assuming you are willing to hold the stock for long term.

A little bit of background– On April 20 Deep Horizon Oil Rig exploded resulting into one of the largest environmental disaster on the face of earth. Since the initial estimates of 1,000 barrels per day leak has morphed into a monstrous 100,000 barrels/day. Since then BP’s market cap has been cut into half (over $90 Billions). OPNewsletter members profitably played a market neutral (but speculative) option trading strategy on BP and got out on May 5th, when BP was still a $50 stock.

Together with BP, Transocean (RIG) also nose dived and we decided to play a bull call debit vertical spread as soon as BP’s TOP KILL started to function and it reported 70% success chance. It failed and so did our Transocean trade (we still have 24 days if that pleases the hearts). The RIG dipped all the way to $41.88, a five year low and by then IV jumped over 100%.

So how to take advantage of this set-up?

So the Trade set-up is-
RIG, as I consider, is a quality stock and based on my understanding, it doesn’t have to pay any huge sums for the spill. The business will be affected due to ban but they will gain more later as this ban is going to create a supply/capacity crunch a little later on. It is at multiple year low and I am ok to take risk. So I assume to buy, for example, 200 stocks at $48.96

The IV is unusually high, so I choose to write a call against my 100 stocks and write naked 1 put (to purchase another 100 stocks if I am assigned).

  • Purchased 100 stocks at 48.96
  • Sold Jul 50 Call @ $3.80
  • Sold Jul 50 Put @ 4.95

If by July options expiration RIG stays above $50, I shall be making $979 excluding commissions. That’s about 10% returns for almost a month’s hold and assuming stock moves up only $1.04. I assume cost as =$48.96*200= $9,792; though less than 1/3rd will be used (thus about 30% profits) due to portfolio margining, but let’s assume this to be the case on a conservative side.

Here are the transaction prices of a real trade-

RIG Trade for OP ArticleThe break even point is $45.10-
=[(48.96*100 (upfront stock purchase) +50*100 (if RIG is assigned for the puts sold))-(380 (call credit) +495(put credit))]/2 i.e. I shall be purchasing 200 shares at $45.10 as opposed to $48.96.

RIG High IV Trade

RIG High IV Trade

The results will be somewhat similar to covered call option trading strategy except the fact that effective capital employed in the latter case is higher vs. option#1.

So let’s recap, key criteria for this relatively simple strategy are-

  1. You have to have absolute conviction in the long term holding of stock. Remember what goes down can go down further.
  2. Implied volatility allows generating roughly 10% returns for 1 month holding period (assuming full 200 shares)
  3. Your trading account allows you to write calls and naked puts.
  4. The trading account is well capitalized
  5. A clear cut risk management plan should be in place before you trade this strategy. The returns are good on expiration but between opening of trade and expiration anything can go against the trade.

Disclaimer- I have this trade in addition to multiple other trades on RIG but I may change my positions anytime. This trade is already making money and I have replaced stocks by options before close yesterday so as to reduce my delta. I may get in with the stocks again. The intention here is to share an example for educational purpose.

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