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In front of tonight’s earnings release, shares of coin and DVD kiosk outfit Coinstar (NasdaqGS:CSTR - News) were up about 2.15% in volatile trade. Analysts expect profits of $0.64 per share compared to the year ago period’s $0.68 on sales of $498.48M versus $391M. At the same time, the latest action from those pros has boutique Compass Point cutting shares to “Neutral” today due to Coinstar’s joint venture with Verizon which looks to add both cost and uncertainty near-term as its business approaches saturation and eventually falls victim to an obsolete technology.

Despite such headwinds, bulls have been putting fresh coin into the options and feeding the February contract. Calls have outpaced puts by a 3-to-1 margin on heavy overall volume approaching 25,000 contracts. The action has forced at-the-money implieds to rise towards 100% and their highest levels in more than two years. That said, premiums are prone to a volatility crush that we’d conservatively estimate in the mid-40s to 50% IV.

Figure 1: Coinstar (NasdaqGS:CSTR - News) Implied Volatility

For traders feeling optimistic and aligned with today’s order flow in Coinstar’s options, a short-term budget rental position of sorts that’s obviously not a keeper in the family library, but one which makes better sense and cents of the situation, is a bull vertical spread.

By executing a vertical, the fore-mentioned crush risk can be easily averted or cut down radically depending on the position’s strikes in relation to each other, as well as the underlying shares of CSTR. With 2.5 point strikes there’s more than a handful of variations to for the softer long delta strategy when mulling calls or puts and keeping the strikes to the nearby or surrounding money variety.

Figure 2: Coinstar (NasdaqGS:CSTR - News) Bull Call Vertical

One illustrated variation of a short-term bull call spread is the February 50 / 52.5 vertical. This particular vertical will require a bit of upside from shares but flattens out vega risk to nearly zero with the stock near 50.80. The current cost is $1.15 per contract which yields a max payout of $1.35. This return of nearly 117% could be realized if shares rally by about 3% and remain above 52.5 at expiration. At the same time, a breakeven of 51.15 would need just 0.8% of upside from CSTR shares.

For sizing on a hypothetical $20K portfolio, given the potential for undesirable gap risk, we see 1% rather than 2% to 3% of one’s capital as more approachable when considering an earnings situation. As this relates to our bull vertical above, this works out to two spreads. In the end, this type of standalone budget rental agreement won’t produce a profit blockbuster in the trading account. However, its sparing use and some consistency with its execution can add to the bottom-line over the course of the trading year—and without having to sweat the occasional dud that’s all but unavoidable for this sort of thing.

Chris Tyler
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual. 

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Strategy Snapshot: Budget Rental Coinstar Bull Vertical