• Trading 101: Trader Loses Big on HPQ?

    by  • October 11, 2013 6:00 am • Trading 101 with Peter Bryans • 2 Comments

    Just two days ago, Hewlett-Packard (HPQ) hosted an analyst day where CEO, Meg Whitman, made some bullish comments about the company going forward. In the options market, there was a big trade that went off the day before this meeting (10/8) in the form of a bearish debit spread. Let’s take a look at this trade and see what the trader was targeting.

    Courtesy of the fantastic team over at “Trade Alert” I have the top option trades for Tuesday, October 8th featured below.

    Top Option Trades
    HPQ
    >> 2500 HPQ Fri 10/11 19.5 Puts (Wkly) trade $0.20  BID
    >> 2500 HPQ Fri 10/11 20.0 Puts (Wkly) trade $0.34  ASK

    It appears that one trader made a bearish debit spread on the weekly options for HPQ. These are options that are actually set to expire today, Friday, October 11th. There are a lot of equities that have weekly options (with expiry dates every Friday) so be sure to check them out. Nonetheless, it is clear that this was a short-term bet that the equity would drop below $20 by Friday. They were most likely anticipating some news from the CEO herself that would then be bad news for the stock (HPQ closed at $20.75 that day). The last time the company reported earnings, the stock gapped down 12.5%.

    The weekly 20-strike puts were bought (to open) for $0.34 while the weekly 19.50-strike puts were sold (to open) for $0.20. This resulted in a net debit of $0.14 ($0.34 less the $0.20) for this debit spread. The trader initiated this trade 2,500 times for a total cost of $35,000 (2,500 x $0.14).

    With the equity closing at $20.75, they were targeting a move down to $19.50, but not below this level. This would be a 7% move in less than 5 days of trading. Keep in mind that this was an out-of-the-money (OTM) option, which has a low delta, and thus a low chance of finishing in-the-money.

    As always, we want to quickly look at the break even level and profit potential before assessing the current status of this trade. With a cost basis of $0.14, the break even level is simply the 20-strike less the debit of $0.14–with HPQ trading at $19.86 (on expiry) the trader breaks even.

    Total profit potential occurs at the 19.50 strike, but not below it because they sold that strike so their gains are therefore capped. Max profits are simply $0.50 less the $0.14 cost–or $0.36. They could profit a total of $90,000 ($0.34 x 2,5000) while risking $35,000.

    Finally, let’s see what happened with the trade….via the daily chart of HPQ (below) you can quickly see the big move higher the day of the analyst meeting. The equity opened at $20.77 and closed at $22.60 on Wednesday, 10/9. Clearly, investors liked what they heard from the CEO, and the trader who made this bearish has been left sitting with a fairly far OTM put spread.

    (courtesy of StockCharts.com)

    In my opinion this was a bad bet ($35,000) for a reward of $90,000 (less than 3:1 risk/reward) where your gains are capped because the adjacent option was sold. When trying to front-run events such as this, it can be rather risky to place these OTM bets using short-term options. With HPQ closing yesterday (Thursday, 10/10) at $22.32 it is very likely that these options will expire worthless and the trader will be left with a total loss. Trading OTM weekly options ahead of events is a tough game.

    Good luck out there.

    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

    2 Responses to Trading 101: Trader Loses Big on HPQ?

    1. Peter Bryans
      October 15, 2013 6:58 am at 6:58 am

      A valid point. Thanks for reading!

    2. Paul Smith
      October 14, 2013 6:33 pm at 6:33 pm

      before others get confused on your maths you should state that 1 option contract is 100 shares. So the 35K comes from 2500 * 0.14 * 100. Otherwise those new to the options market might find your numbers confusing.

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