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 ivolatility.com
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 Fool.com'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