It shines for some, but rains for others

"Bring me sunshine". As Eric and Ernie used to sing. The sun was definitely shining on the market today as the Fed kept interest rates stable, the UK market rose 90 points

I was actually wishing that the market would fall today. This is ironic as most of my positions are long but I have a very big position with a UK Energy stock will provide handsome returns if it falls

I bought some 3 month March 390 puts of this stock in late November 2006 which expire on the 3rd Friday of March 2007. If the shares finish above 390p on this day I lose my money, but if the finish below 390 I make money.

I bought them at 16p so my breakeven point is 390-16p i.e. 374p. They have been steadily falling over the last few weeks from 500p to today’s 429p.

As I mentioned previously, options also have a time value as well as an intrinsic value. So when I bought the options in November the share price was around 480p. The options had no intrinsic value i.e. if they expired tomorrow they would not be above the 390p so they would be worthless. Thus the 16p I paid was entirely time value

As you get closer to the expiry date i.e. 16th March 2007, the time value of the option erodes. So a march 2007 option bought in November 2006 when the price was 480p was worth 16p, but now at the end of February it is only worth 5p and the price is much closer to 390p than before.

In order to make my money back, the share will have to fall to around 400p in the next few weeks as the option value will increase the closer it gets to 390p.

But I’m hoping it will fall further and I think it will
1) A major broker has just given the share a downgrade to 360p. i.e. that’s all they think its worth.
2) One of their power plants has just suffered yet another outage. This gives little confidence to the market that their business is running well

Will the share fall further. Lets wait a few more days to see
So “bring me sunshine” could be the song I am singing soon !!