How to Profit from a Stock Split with Options

02/01/2011 3:03 am EST

Focus: OPTIONS

Whiting Petroleum Corporation (WLL) last week announced that its board of directors declared a two-for-one split of Whiting’s common stock to be effected through a stock dividend. According to the news, stockholders of record at the close of business on February 7, 2011 will be entitled to receive one additional share of Whiting common stock for each share of common stock owned as of that date. Whiting anticipates that the additional shares of common stock to be issued as a result of the stock dividend will be issued in book-entry form on or about February 21, 2011.

Originally, I wanted to share this trade idea when WLL was bouncing off of its 50-day moving average, but couldn't as I spent time on NFLX earnings instead. In any case, I think WLL still offers a good opportunity due to this event.

First, for those who don't know WLL, here is a brief description from Google Finance:

“Whiting Petroleum Corporation is an independent oil and gas company. The Company is engaged in acquisition, development, exploitation, production and exploration activities primarily in the Permian Basin, Rocky Mountains, Mid-Continent, Gulf Coast and Michigan regions of the United States. During the year ended December 31, 2009, the Company’s average daily production was 55.5 thousands of barrels of oil equivalent/day (MBOE/d). As of December 31, 2009, its estimated proved reserves totaled 275 million barrels of oil equivalent (MMBOE). The Company’s Permian Basin operations include assets in Texas and New Mexico. As of December 31, 2009, the Permian Basin region contributed 123.3 MMBOE of estimated proved reserves to its portfolio of operations, which represented 45% of its total estimated proved reserves and contributed 11.7 MBOE/d of average daily production in December 2009.”

How to Play the WLL Stock Split via Options

The basic concept is that stocks usually trend higher leading into the split day because many investors/traders think that stock split is a sign of confidence. Since many traders and investors follow the crowd, it also serves as a self-fulfilling prophecy.

Of course, not all the stocks that announce a split go up, so one has to be selective in choosing to play this potential uptrend that might last for a few weeks. I think WLL may be one of those that might rise.

Below is a one-year chart for WLL:


Click to Enlarge

A bull call debit spread, or bull put vertical credit spread, is one of the ways to play a potential uptrend. I am personally of the opinion to sell to open a February 115/110 bull put vertical spread. As of the prior close, this spread will bring $1.17 credit, and thus $3.83 on margin. By February 2011 expiration, if WLL stays above $115, it may generate 30% returns, not including commissions. Be sure to check for current prices before entering any trade.

The breakeven for this trade (at the time of writing) will be $113.83 ($115-$1.17), below which the trade will start to lose money and will lose 100% by February expiration if either 1) It is not adjusted, or 2) It is not taken off for a loss.

I usually prefer to book profit/loss at 15% -18%. Here is the risk/reward chart for the trade:


Click to Enlarge

This is a Theta-positive, negative-Vega trade. Once it's set, you can leave it while monitoring for stock movement. As long as stock isn't trading below $115, the trade will be fine. Thirty percent for less than four weeks (assuming WLL is above $115 by February expiration) is an excellent risk/reward for a limited-risk strategy.

Just make sure that you have a risk management plan in place should WLL move against your position. For a starter, one of the simple adjustment plans is to open a bear call spread and convert into a fly as soon as you are feeling uncomfortable with the position.

Disclaimer: As of this writing, the author(s) did not have any positions in WLL, but may open positions at any time. These may be opened using either any of the strategies discussed above or a different one. Opinions may also change at any time. Please do proper due diligence before investing even a single dollar.

By the Staff at OptionPundit.com

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