UBS: Sell S&P 500 options

Jul 28, 2010 @ 3:41 pm

By Bloomberg

Investors should sell Standard & Poor’s 500 Index options to profit from a “range-bound” equity market that’s likely to fluctuate less this year, UBS AG said.

Investors should sell a December 1,200 call and a December 1,100 put, a strategy known as a “strangle” that profits from decreasing volatility, options strategist Mitchell Revsine wrote in a note. Options prices indicate that the S&P 500, which fell 0.2 percent to 1,112.07 as of 1:15 p.m. New York time, won’t exceed 1,250 -- a level near its high since Lehman Brothers Holdings Inc.’s 2008 bankruptcy of 1,255.08 -- or decline to a one-year low of 950, he wrote.

The S&P 500 is up 7.9 percent this month to erase a 2010 loss of as much as 8.3 percent as economic reports signal that the recovery may continue. Since July 12, 81 percent of S&P 500 companies reporting quarterly results have topped estimates. The index is still down 8.6 percent from the 19-month high of 1,217.28 it reached on April 23.

“The optimal outcome at expiration would be for the index to be above the put strike and below the call strike, in which case the entire premium would be retained,” the New York-based strategist wrote. “The option market is currently implying a 66 percent probability that the trade will be profitable, to some degree.”

Selling a strangle is a bet that the shares won’t move beyond either strike price before expiration, allowing the seller to keep what the buyer paid. Options are derivatives that give the right to buy or sell assets at a set price by a specific date. Investors use the contracts to guard against fluctuations in the price of securities they own, speculate or bet that volatility, or price swings, will increase or decrease.

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