Sometimes, There’s Not Much News in the News
Let’s face it. News moves stock prices. This is why earnings season is so exciting for traders. Every day, we see more news and traders get the chance to react to the news. It’s possible to make large gains in a short amount of time during earnings season.
But, news about a company can include more than earnings. There are, of course, corporate actions like mergers, acquisitions and share buy backs. These events also move stock prices. Increasingly, and especially with large companies, we are seeing news about litigation and that can be important.
There will be times when litigation is a market moving piece of news and other times when traders shrug off the news. The market may ignore news if it seems inconsequential or if it is confusing and presents an unknown picture to traders.
News From GM Fails to Move the Market
Recent news about General Motors Company (NYSE: GM) is an example of news that seems like it should be significant but failed to push the price of the stock either up or down in a significant way.
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A federal bankruptcy judge decided that a settlement agreement that would require General Motors to pay $1 billion in stock to car owners suing the company over faulty ignition switches was not enforceable and the issue would need to be revisited by the parties.
Judge Martin Glenn of the U.S. Bankruptcy Court in New York said the agreement that car owners had reached with a trust that holds many GM liabilities from before its 2009 bankruptcy was not valid without signatures. That trust is often called “old GM” and the operating company with publicly traded shares is “new GM.”
The claims that the agreement covered arose as a result of GM’s 2014 recall of millions of vehicles with defective ignition switches. One of those defects has been linked to 124 deaths.
Lawyers for the car owners and the trust had agreed to a deal last August, but for some reason the agreement was never formally signed by all of the parties involved in the negotiations.
For its part, the trust (old GM) had a change of opinion several days after the agreement was reached and instead decided to accept new GM’s offer to help pay for the trust’s defense against the car owners’ claims. This means months or years of litigation is likely.
Bankruptcy Judge Glenn was not happy with the conduct of the trust’s lawyers, saying in his order that their “dishonesty, or bad faith, was not lost” on him. But, he acknowledged that despite the trust’s last-minute change of heart, applicable laws did not allow for the enforcement of an unexecuted agreement.
Steve Berman, one of the lawyers representing the car owners, in a statement said his side was disappointed but saw a victory in the ruling nevertheless.
“Judge Glenn clearly thought the trustee and (law firm) Gibson Dunn acted in bad faith, and we see therefore they both must be removed as trustee,” Berman said, adding that plaintiffs would take up settlement talks with a new trustee.
GM declined to comment.
Under the deal, the plaintiffs’ lawyers worked out, GM would have been required to contribute $1 billion in stock to compensate car owners.
The settlement called for the trust to accept $10 billion in claims to resolve about 11.9 million allegations over economic loss and between 410 and 500 personal injury and wrongful-death claims.
About 2.4 million claims, involving vehicles sold after GM’s bankruptcy, would have remained pending in another court.
GM has already paid roughly $2.5 billion to settle ignition switch-related claims, including $900 million to settle a criminal probe by the U.S. Justice Department.
The Stock Shrugs Off the News
GM was unmoved on the news. The stock remains in a trading range that defined its price action for the past few months.
The longer term chart shows the GM has a tendency to fall into large trading ranges that last for months. This isn’t totally unexpected. GM is a large company in a slow growing industry.
It takes time for significant changes to unfold in the auto industry and significant changes will be relatively rare. In the time between changes, we could expect the stock to remain range bound while investors wait for the next piece of market moving news.
A Strategy to Benefit While Waiting for More Details
As we wait for clarity on the impact of these various factors, we could see stocks settle into a trading range. One best option strategy that benefits from a stock in a trading range is an iron condor. This strategy has the added benefit of carrying limited risk.
To open an iron condor trade, the investor sells one call while buying another call with a higher exercise price and sells one put while buying another put with a lower exercise price. Typically, the exercise prices of the calls are above the market price of the stock and the exercise prices of the put options are below the current price of the underlying stock.
In an iron condor, the difference between the exercise prices of the two call options will be equal to the difference between the exercise prices of the two put options. The final requirement for this strategy is that all of the options must have the same expiration date.
The risks and potential rewards of the strategy are shown in the following diagram.
Source: The Options Industry Council
The maximum gain on this trade is equal to the premiums received when the position is open. The maximum risk is equal to the difference in the two exercise prices less the amount of the premium received when the trade was opened.
Opening an Iron Condor in General Motors
For GM, the trade can be opened using the following four options contracts:
As you see, all of the options expire on the same day, Friday, February 6.
The difference in the exercise prices of the calls or puts is equal to $1.00. Since each contract covers 100 shares of stock, this means the maximum risk on the trade is equal to $100 less the premium received when the trade was opened.
Selling the options will generate $1.15 in income ($0.30 from the call and $0.85 from the put). Buying the options will cost $0.95 ($0.50 for the call and $0.45 for the put). This means opening the trade will result in a credit of $0.20, or $20 for each contract since each contract covers 100 shares.
The maximum risk on the trade is equal to the difference in strike prices ($1.00) minus the premium received ($0.20). This is equal to $0.80, or $80 since each contract covers 100 shares. Many brokers will require a margin deposit equal to the amount of risk. That means this trade may require just $80 in capital.
The maximum gain on the trade is the amount of premium received when the trade is opened. In this case, that is $0.20 or $20 per contract.
The potential reward on the trade ($20) is about 25% of the amount risked, a high potential return on investment for a trade that will be open for about two weeks. If a trade like this is entered every two weeks, a small trader could quickly increase the amount of capital in their trading account.
The iron condor is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that should be lower than owning the stock.
These are the type of trading strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.