• Trading 101: Another Spread Trade Illustrated

    by  • August 30, 2013 6:00 am • Trading 101 with Peter Bryans

    I always like looking for signs of big trades out there, as they give me somewhat of an idea as to what potential “big money” players are expecting. Under Armour (UA) is a retail name that I have been stalking on the long side, and earlier this month a large trade went off on one of the option exchanges.

    Below is a daily chart (as of the close this past Wednesday, 8/28). UA has posted a YTD gain of nearly 50 percent. Retailers have been a mixed bag lately, and you can find many ideas on both the long and short side. As mentioned, I’ve had a long bias toward the equity as it has remained a strong player in the midst of an increase in short interest.

    (couresty of StockCharts.com)

    After searching through option activity on Trade Alert (a high-end alert service we subscribe to here at Schaeffer’s), I came across the below trade that was made on August 7th–when the stock was trading up near $70. The following is a trade that was made with a bearish bet toward the equity.

    Top Option Trades

    UA 69.50 close, 8/7

    >> 2000 UA Oct13 67.5 Puts trade $2.35  ASK

    >> 2000 UA Oct13 65.0 Puts trade $1.45  BID

    >> 2000 UA Oct13 62.5 Puts trade $0.95  MID

    (info courtesy of Trade Alert)

    It is likely that this was a 67.50-65-62.50 put spread. The investor bought (to open) (BTO) the 67.50-strike puts on the ask for 2.35. Because this activity was on the offer price (ask) we can infer that this was BTO.

    The 2,000 lot of 65-strike and 62.50-strike puts were likely both sold (to open) (STO), at prices of 1.45 and 0.95, respectively. We can infer this based on the fact that the trades went off on the bid and the mid prices. The combined credit for the STO options is $2.40 (0.95 + 1.45). This trade resulted in a net credit to the trader’s account of $0.05 (2.40-2.35).

    Since the investor is long the 67.50-strike puts, they will profit on any move by the shares below this level. Since they are also short the 65-strike puts, they will be in the hole for any price below 65. The ultimate worst-case scenario is if shares of UA plunge all the way below the 62.50 level. From here, the trader will already be just at break even. They stand to gain 2.50 from being long the 67.50-strike puts while they will also be on the hook for 2.50 from the 65-strike puts if UA is trading at 62.50 exactly. A drop below 62.50–and things can get ugly.

    Where are maximum profits achieved? Should UA close at $65 exactly on expiration Friday, the trader rakes in 2.50 (67.50-65) plus the initial $0.05 credit from that big trade they made all the way back in August. This total comes to $2.55.

    Now, more importantly, what is the trader targeting? It is hard to say exactly, but the activity indicates a bearish bet toward the equity. As of now, UA has earnings scheduled for next quarter around October 15th. This would be before these October options expire on the third Friday of that month–October 18th. Perhaps they are targeting a move down to just $65 following earnings. Or, another plausible scenario, is that they are looking to place a protective put for the shares that they already own, and wanted to take in a net credit for the trade. It is unlikely that they are hedging their shares, as there is no real reason to take on the extra risk by selling two different strikes.

    This spread trade is targeting a much more precise price level by a certain date. To be sure, this is a rather tough game. A 2,000 lot is a sizable trade, and it will be interesting to see if this was “smart” money or just “dumb” money after all. The earnings report is sure to have this trader on the edge of their seat.

    Good luck out there and keep studying up on options.

     

     

     

    About

    Peter Bryans joined the Schaeffer's Investment Research trading team as a Trader in April, 2012. A graduate of the Fisher College of Business at The Ohio State University -- where he concentrated in Finance -- Peter previously held internships with an insurance broker and a wealth-management firm. In his current role, Peter trades a variety of our real-time option services and also hosts our "Options Apprentice" weekly webinar presentations.

    http://www.schaeffersresearch.com