Try an Options Spin With Mattel

 | Apr 02, 2014 | 9:00 AM EDT  | Comments
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I took a look at Mattel (MAT) Tuesday. While I didn't spend my youth playing with Barbies, I did take a few Hot Wheels for a spin around the block. While some investors may not be ready to take the stock of Mattel for a spin, what about an alternative?

As I mentioned already, the chart doesn't paint a bad picture for the bulls, but after the recent push higher and still with the overhang of a miss last earnings, there could still be doubters. Mattel is now a show me stock and the doubts could spread to current holders, so a pullback is still possible.

What about the idea of selling puts to try and capture the dividend while providing some downside cushion, especially if you are willing to sacrifice upside? Well that could work. Mattel does seem to have strong support around $37 as well as $35. This may be both good and bad. And in this case I'm going to focus in on why selling the $35 put may actually pose more risk than selling the $37-35 put spread. Crazy, right? A day's late April's Fool joke? No.

Let's take a quick look back at the chart from Tuesday. The recent breakout came from the $38.40, which should act as a first level of support. The second level of support comes where the 21-day simple moving average ran just below the stock in March, which I'll call $37 here. The final level is the post earnings disappointment low of $35. Put those numbers aside for a moment as we'll be back to them soon.

Mattel
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Mattel should be paying its $0.38 quarterly dividend in late May. Unfortunately, if history is any guide, then the stock will go ex-dividend after the May 17 option expiration. If I want to sell a put to try and capture this dividend, I give myself three options. I would sell the May $37 put for around $0.40, or the July $35 put for $0.45. Both of these would be naked so my total risk sits in the mid-$3000 range although my margin requirement will be much less. One other approach would be to sell the July $37-35 put spread for a $0.40 net credit.

At first glance that last option would seem the least attractive. While the margin requirement is only $160, significant less than either of the first two examples, the risk of any type of loss is greater. A trader would be required to hold this bullish put spread an extra two months against the short May put. And the bullish put spread has 5% less cushion to breakeven compared to the July $35 short put. A no brainer to pass on this one, right?

Back to the charts. Let's review those support levels. Forget the first one for now. If it holds, then I'm fine no matter what I choose. The next two levels are $37 and $35. In theory, $37 should hold, and if so, then again any of these will do just fine. But what if $37 fails? Well, if I am short a naked $37 put, I probably need to consider getting out. If I'm short a $35 naked put, then I'm just on alert. If I'm short the put spread, I know I have a limited risk, so I can be more patient.

Even worse, what happens if Mattel visits $35? Well, this should be support, so I can hold the short put spread since I have a defined risk and there is a good chance the stock bounces. However, if I'm short a naked May $37 put and I haven't already stopped out, then I am really nervous at this point.

In fact, I'm really nervous if I'm short a naked July $35 put here as well. Why? Well, there is nothing but a black hole under $35. It is Maximilian waiting to chop me up. The losses could come quick and be significant. If the stock falls below $35, then I simply could not rationalize holding a naked put.

Of course, it could be a fake out on the breakdown or a quick whoosh lower followed by a quick recovery back above $35. With a bullish put spread, I could wait out the move all because of the defined risk.

In the end, I find the short July put spread as the play that would allow me as a trader or an investor with the most comfort in holding over several months even through another earnings release. It really does come down to risk tolerance. When looking at a stock that you want to sell puts, I find selling the strike which is the support level of the stock, a big mistake.

If your comfort level is to use naked puts, then find a setup where your naked put is below a major support level; otherwise consider a bullish put strategy like the one discussed here.

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