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Intermediate Strategy: Making the Case for Zagg's Bull Call Spread

By Chris Tyler, Optionetics.com | Wed March 21, 2012 8:22AM PT


When is a bull call spread better than a bull put spread or an outright long call position? A reasonable enough response would be if a trader expects a stock to rally but also possibly sees limited upside and / or premiums as being expensive. In this type situation the call spread would be favored over the put spread’s typically smaller credit which embodies its max profit. At the same time, due to the higher cost to purchase an outright contract and not expecting a Buzz Lightyear style “To infinity and beyond!” move in shares; it’s likely the bull call spread would be the stronger choice versus a long call position too.

Another situation less discussed but one where a bull call spread might be the correct trader accessory compared to these other two position types is when high levels of short interest is involved. To support our case, pardon the pun, we’d like to look at electronics skins, covers and / or  cases manufacturer Zagg Inc (ZAGG).

Truthfully, we’re on the fence regarding Zagg’s prospects which seem to rest heavily on its ability to sell its accessory product for Apple-related (AAPL) computer gadgets. And while we could appreciate building the bull case technically, we can’t help but respect the near 49% of shorts in ZAGG’s float and attached short-to-cover ratio in excess of 7 days. Many traders, at least those seeing the bears as being in the bulls-eye, might be quick to point out how those that are short will be forced to cover. In turn, that action can help fuel shares even higher; maybe even to infinity and beyond, in their wildest dreams of course.

Shorts however, are overall, accepted as a more sophisticated group of traders and typically with deeper pockets too. We respect the idea they’ve likely done a thorough job of kicking the company’s proverbial tires before they actually start acquiring a bearish position in a stock. That said and in appreciating ZAGG’s current resident bear contingency, “sure they could be wrong", but they could be right too and there is a lot of them putting their money down and making that commitment.  

From that vantage point, the one respectfully spying on all those shorts, a bullish vertical inherently makes sense as the dollar commitment per contract is, generally speaking, less than an outright call. Further, by hedging with this type spread, the trader is making an immediate compromise on their enthusiasm for the name by containing the position’s upside potential. It’s kind of like a sacrifice fly in baseball where you make a play which hurts a little but ultimately helps the home team win the game with a score.

The reason a bull call spread might be considered the stronger choice over the put spread when high short interest is involved and besides the hoped for potential of a strong short cover rally occurring; is the trader may find they’ve been assigned on their short higher strike call contract prior to expiration. This situation might become a reality if another trader (likely a short) is in need of converting a long call hedge into long stock because they’ve been called in on short stock.

If assignment sounds like a bad thing, it's not the case for the bull call spread holder. By having ownership of the lower strike call, the trader in this enviable position of receiving an early assignment would enjoy a now guaranteed ability to receive their maximum profit. All they’d have to do is exercise their long call, at which time they’d receive the difference between strikes minus the initial debit paid for the spread. Maybe even better and if the account can accommodate short stock and shares can actually be held short; this bull could maintain the position and become a turncoat and hopeful bear. In effect, they’d have a synthetic long put on for a credit equal to their profit. Case closed.   

 

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
Optionetics.com ~ Your Options Education Site
Visit Chris Tyler’s Forum
 
The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual. 

 


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