Sherwin-Williams (SHW): Paint Your Portfolio with a Credit Spread
09/28/2009 10:40 am EST
Sherwin-Williams is a household name that everyone who’s ever done a substantial amount of house painting is likely to be familiar with. Not only do they make great paint, but there is also a very interesting, fairly low-risk option credit spread available, one that takes its cue from the current technical/fundamental state of the company’s common stock (ticker: SHW). Let’s have a look at the weekly chart for SHW and learn why selling what is known as a ‘bear call spread’ appears to be an attractive proposition right now
Graphic credit: Metastock /WB Detrend RT EOD from ProfitTrader for Metastock
All of the essential technical confirmations necessary to sell a low-risk, high probability bear call spread are evident on SHW’s weekly chart:
- The stock is confirming that a weekly cycle high has been made, as evidenced by the Detrend oscillator (blue histogram at bottom of chart) and the action of the double-smoothed stochastic indicator (red indicator at bottom of chart). The two indicators work exceptionally well to locate likely cycle highs and lows in every time frame, and they appear to have confirmed a weekly turn lower in SHW. In addition, notice the pronounced price/momentum divergence between the recent Detrend highs in relation to the price action on the chart. That’s another likely confirmation that the weekly cycle is going bring SHW shares down to lower levels.
- The stock has two significant overhead resistance levels, one at $62.50-$62.75 and the next right at $65.00, which is the lower option strike price for our bear call credit spread.
Since SHW is trading just a tad lower than $60.00 as I write this, selling an out-of-the-money credit spread (with a short strike at $65.00 and a long strike at $70.00) that has two significant resistance barriers protecting it from going into the money too quickly looks like a great low-risk option strategy.
Graphic credit: Thinkorswim
Here are the particulars for the credit spread:
Sell 1 November 2009 SHW $65.00 call (SHWKM)
Buy 1 November 2009 SHW $70.00 call (SHWKN)
Net credit received: $.70 or better ($70 in dollar terms)
If you receive $70 for selling this option spread, your maximum risk on the trade (if held to November options expiration on 11.20.09) is the difference between the two strike prices ($250) less the option credit received ($70), or $180. A wise trader will close the trade out long before the spread has a chance to go in the money, however, and close monitoring of SHW’s price action near the aforementioned resistance levels of $62.50/$62.75 and $65.00 should give them plenty of advance warning should the stock quickly reverse higher after putting on this spread. Under no circumstances should you let the spread double in price (to about $1.40) before deciding to close it out at a loss.
If SHW falls a bit further after selling the spread, simply meandering back and forth for the next few weeks, the spread will have lost a fair amount of its remaining time value, and might even be able to be bought back at say, $.25 or $.30, allowing an impatient trader the luxury of buying the spread back early in order to collect a quick and relatively painless profit. If SHW breaks the weekly uptrend line (red line currently near $58.00) and really drops fast, the spread could even fall to $.10 or $.15, with a very low probability of expiring in the money. Traders who sell multiple spreads might then choose to buy back a portion of their positions early, letting the rest of the positions run in an attempt to collect all of the premiums if the stock fails to expire in the money at options expiration.
Overall, this looks like one of the “safest” bear call spreads available now. The premiums are healthy, the technical barriers between today’s price and the lower strike price are significant, and the entire broad market is on track to move lower (with some minor corrective upswings possible) between now and early- to mid-November 2009, based on the weekly price cycles in the S&P 500 and Russell 200 indexes. Work your best bid price, size your positions wisely (being sure not to risk more than 1-2% of your account equity on this trade), and be prepared to take early profits, especially on a sharp, swift drop. The best options traders are quick to take the first “logical” profit and quick to bail out of any trade that fails to cooperate as intended. The support/resistance barriers discussed here are the key elements to watch, so be sure to take decisive action on significant breaks above or below any of them, should you actually take this trade.
By Donald W. Pendergast Jr. of ChartW59.com