Saturday, February 02, 2008

A Credit Spread on Intuitive Surgical Inc (ISRG)

Dear fellow options trader :

As mentioned in my previous entry using a credit spread on Apple Inc. earnings, options are getting expensive for stocks about to announce earnings. This is due to build-up of huge implied volatility in the options premium and the current volatile situation of the stock market.

Checked that Intuitive Surgical Inc (ticker : ISRG), maker of the da Vinci surgical systems, would be reporting earnings on 31 Jan 2008 (Thursday) after-market-close (AMC).

A look at the volatility chart of ISRG revealed that the implied volatility of the stock options has increased to more than 80% till the eve of earnings announcement day compared to the 30-days historical volatility of about 60%. This meant that the options premium would once again be expensive due to the built-up of high implied volatility.

Chart courtesy of

With such high implied volatility, I understood that the further strikes out-the-money options could still fetch some good premium value. Thus, I set up a credit spread where I sold 1 no. of Feb 220 Put and bought a 1 no. of Feb 210 Put and collected a premium of about $260.00 (excluding commissions) per trade. This bull put spread was set up when ISRG was trading at around $242.00, meaning the Feb 220 Put I sold was about $20.00 out-the-money.

The bull put spread was set up basically due to my bullish outlook of ISRG share price after earnings announcement. The bull put spread would make money (ie. I could collect the full or partial $260.00 credit, excluding commissions) if ISRG share price would gap up a lot, stay the same or drop a little after the earnings announcement. In addition, with the collapse of implied volatility after earnings, that could provide an opportunity for me to buy back the sold leg cheaply if I want to close the sold leg.

I felt Intuitive Surgical Inc's has dropped far too much since Jan 2008 for a company which has not much competition in the specialised field of providing robotic-surgery tools. Although research analysts were generally mixed about slowing placements of the da Vinci systems and concerned whether ISRG would be able to withstand the credit crunch, I read from a's report that the installed surgical robots still need expensive disposable supplies to function, and the more practice the doctors receive, the more disposables they would use up. For 2 days on 29 Jan 2008 & 30 Jan 2008, ISRG dropped more than -$38.00 to $235.00. I felt that if ISRG could report good earnings quarter, the share price could recover this loss of $38.00 during the past 2 days and could went up a little further. There were also other signals that I looked for and I would certainly share the information with my fellow opt-in subscribers list when the time is right as I would need to test-run them for a few more earnings quarters and to see whether they are consistent.

On 31 Jan 2008 AMC, Intuitive Surgical Inc (ticker : ISRG) reported Q4 earnings of $1.24 per share, $0.20 better than consensus of $1.04; revenues rose 68.2% year/year to $189.4 mln vs the $175.9 mln consensus. The management were pleased with the company's fourth quarter revenue, income, and cash flow growth.

On 1 Feb 2008 (Friday), ISRG gapped up +$38.00 to $292.00 and went up as high as $307.00 (another +$15.00) intra-day. I bought back the Feb 220 Put sold leg when market opened. I could have let the Feb 210 Put bought leg expire worthless but in order to illustrate the outcome of this credit spread, I closed the position and incurred an exit commission. I felt that this credit spread could have been more cost-effective & I could have collected a higher premium if it was administered with a discount broker since the commissions would be cheaper.

The Lunar New Year is approaching and I wish to take this opportunity to Wish Everyone a Healthy & Prosperous New Year !!!

Gong Xi Fa Cai !!! Huat Ah !!!

Yours Truly,

Tony Chai
Options Trading Resources