STONECO: Brazil's Fintech Fiesta (UPDATE)
Rolling Into The Next Phase.
Executive Summary
Rolling the trade and stretching the call.
Moving into a lower and later dated strike reduces sensitivity to immediate pullbacks.
Total capital at risk remains the same.
1. Recap Situation
We tried to tame the Brazilian jungle with a long wide strangle, but we soon realized that we had chosen a maturity date that required StoneCo to move faster than it wanted. We could have allowed more time to breathe. We experienced a gradual decline in the stock price that, at one point, ate up more than half of our option premium while our long put position provided minimal protection.
It's perfectly ok to experience temporary drawdowns; they remind us of our humanity and make us feel alive. Thanks to Curupira, a Brazilian forest god symbolizing resilience and perseverance, we've found the strength to overcome those drawdowns. We are optimistic about the future and remain confident that good times are still ahead for StoneCo.
von Randow, J. (2023, August 1).
Whatever, von Randow, cut the hippie crap and straighten those shoulders.
Moving on, we decided to update the trade and extend the call to January 2024. This time, we chose not to spend money on a put hedge, as it has only exacerbated the theta burn without providing significant downside protection. Even though it could make a difference should the price plummet abruptly, we firmly believe that StoneCo has already bottomed out.
Check out the original article below.
2. Why Now
We only have 80 days left on our contracts. The share price has returned to its break-even point, and the earnings hand grenade will be thrown into the mix in less than two weeks. From a risk management perspective, it's prudent to close the put side of the trade and roll the call to a lower and later-dated strike. This approach lessens the trade's sensitivity to immediate pullbacks. The increased options delta of the lower strike and extra time on the contract will effectively make this happen.
Here's a simple back-of-the-envelope calculation: If the share price pulls back to 13, our current 18-strike call option will lose 60% of its value. On the other hand, an option with a 15-strike would lose only 45% of its value under the same conditions. Furthermore, extending the contracts from October 2023 to January 2024 could reduce that immediate 45% loss to just 30%.
If the share price increases to 18 within the next month or two, we could still expect a return of 80-90%. The trade could also be closed outright if we neither believed in the business nor anticipated a breakout. Waiting for the next pullback is an option, but this would risk missing out on immediate further upside action.
3. Trade Execution
We are closing the long 8 put, rolling the 18 call down to 15, and moving it out from October to January, giving the trade three more months and reducing its sensitivity to the downside.
The previously wide, long strangle has become a simple 15-strike call with 170 days remaining on the clock. We want to ensure that our total risk - the cost of the call ($2.30) times the number of new contracts - isn't greater than our initial risk, which was the cost of the original contracts ($0.71) times their number, minus any potential loss incurred at the time of rolling.
3.1 Trade Entry - June 5, 2023
The options chains are relatively liquid, considering it’s an emerging market play; our average fill was 0.71, slightly above the mid-price level.
STNE: Payout Chart for a Long Strangle, Buy to Open.
Total: 0.71 Debit.
3.2 Trade Update - Aug 1, 2023
First Leg. STNE: Payout Chart for a Short Strangle, Sell to Close to Roll the Call.
We got filled at the lower end of the bid / ask spread.
Total: 0.60 Credit.
Second Leg. STNE: Payout Chart for a Long Call, Buying to Open.
We got filled at the upper end of the bid / ask spread.
Total: 2.30 Debit.
As mentioned earlier, we will not take on any additional risk. The cost of the call, set at $2.30 multiplied by the number of new contracts, should not exceed our original risk of $0.71 times the original contract quantity.
We only reclaimed $0.60 after the trade roll, so the risk taken over into the roll should not exceed $0.60 times the original contract quantity.
All BrainDozer articles are purely educational; they are not tailored to any particular individual or portfolio and do not constitute investment advice. Let us know if you are interested in implementing any of our ideas. Perhaps we can help or point you in the right direction.