Bears in the Butterfly Garden

By option_review

July 8, 2009

295

Today’s tickers: MS, EXPE, FCX, VIX, XRT, GPS, XLP & WFC

MS – A massive, albeit lopsided, butterfly spread was established on MS today amid a more than 3.5% decline in shares to $25.19. The highly bearish play was initiated by an individual who expects to profit from significant declines in the price of the underlying by expiration in October. The butterfly spread defied typical parameters seen in the strategy. The body of the spread involved the sale of 20,000 puts at the October 21 strike price for 1.45 apiece. But, the lower wing, which would typically have half as many contracts as the body, also had 20,000 puts which were purchased for 79 cents each. Finally, the conventional upper wing at the October 25 strike had 10,000 puts bought for 3.19 per contract. The bottom-heavy wing with twice as many puts as the upper wing suggests that the trader is prepared for shares to slip beneath $18.00 by expiration. If shares slipped beneath the lower strike price, the trader, who is still net long 10,000 put options, would see the value of the puts appreciate. Perhaps this investor is banking on a renewal of financial calamities by the fall. – Morgan Stanley

EXPE – Bearish sentiment on the online travel company was apparent after one trader spawned a butterfly in the October contract. This individual probably doubts that the demand for travel and vacation accommodations is heading anywhere but south given rising unemployment statistics. Shares of EXPE have slipped along with the broader market today by 1.5% to $13.59. The butterfly spread was initiated through the sale of 22,000 puts at the October 10 strike price for a premium of 47 cents apiece. The body was flanked by the purchase of two wings. The higher October 15 strike had 11,000 puts purchased for 2.56 per contract and the lower October 7.5 strike also had 11,000 puts picked up for 18 cents apiece. We would like to point out that unlike traditional butterfly spreads, which have equidistant strikes, this butterfly was born with lopsided wings as the lower strike is just 2.5 below the central exercise price rather than 5 points. The investor has realized a net cost of 1.80 and will begin to amass profits beneath the breakeven point at $13.20. Maximum potential profits of 3.20 would be attained if shares of EXPE drop to $10.00 by expiration in the fall. The trader’s decision to truncate the length of the lower wing indicates that, although he is definitely expecting shares to decline, he does not believe shares will halve over the next four months. – Expedia, Inc.

FCX – Despite the 2.5% plunge in shares of FCX to $43.87 today, bullish activity was observed on the mining company by investors hoping for a recovery in the stock by expiration in November. Current bearish movement plaguing FCX likely stems from the softening in demand for commodities and the strengthening of the dollar. The rise in investor uncertainty, as measured by the VIX, and declines across the market have not precluded one investor from staking a bullish claim in call options. The trader was seen unfurling the wings of a butterfly spread in the November contract. It appears that this individual sold 16,000 calls at the central November 60 strike price for 2.68 apiece. Simultaneously, the wings were constructed through the purchase of 8,000 calls at the November 55 strike price for 3.89 each, along with another 8,000 calls at the November 65 strike for 1.87 a-pop. The net cost of the bullish play amounts to just 40 cents and yields maximum potential profits of 4.60 per contract if shares can rise 37% to $60.00 by expiration. By enacting the butterfly spread strategy, the trader has positioned himself to reap the benefits of a reward-to-risk ratio of more than 11-to-1. The individual responsible for this transaction apparently believes that FCX will return to the $60.00-level, where it was trading less than one month ago, by the time November’s expiration rolls around. If the stock does rebound to $60.00, the investor will have racked up a handsome sum of $7,360,000. – Freeport-McMoran Copper & Gold, Inc.

VIX – Despite a pre-market rally for S&P index futures encouraged by a 2010 growth upgrade from the IMF, the market quickly ceded its positive tone and inspired some volatility bidding. Two noteworthy trades stand out. First, the liveliest contract appears to be the July 32.5 call where more than 17,000 contracts changed hands at premiums of about 2.30 each. The Vix is up sharply today at 32.83. This at-the-money call buying suggests a need to protect risks to portfolio rather than wager for a much higher reach by the fear gauge. One likely reason behind today’s move is perhaps a mid-morning surge in the value of the Japanese yen, which has been bubbling under in recent days. Often seen as a safe haven as global economic health deteriorates, a sudden burst of demand today simply put risk aversion front and center. Elsewhere in the November contract it appears that an investor wrote a strangle combination as he sold 11,000 27.5 puts and the same amount of 40 strike call options for a combined premium of 5.25. The strategy is only at risk in the event that come November’s expiration the Vix has strayed outside breakeven parameters of 22.25 and 45.25. A settlement within the range of the strikes chosen today would leave the investor taking the full credit. – CBOE Volatility Index

XRT – For the second day in a row it appears that an investor is casting bearish aspersions on the fortunes of retailing stocks, at least through options activity on the SPDR Retail ETF. A put butterfly traded 50,000 times yesterday in the July contract and the identical trade showed up on our market scanners once again Wednesday. The combination centers on the 24 strike price and compares to a current price for the XRT of $26.13. Today’s execution all took place at mid-market prices, yet we doubt that the investor enacting yesterday’s trade quit the field for a two-cent loss so quickly. It’s more likely that either the same or a new investor is adding the same position. The combined premium today is 33 cents compared to yesterday’s 35. The combination involves 50,000 July put options at the 24 strike in conjunction with 25,000 puts at each of the surrounding 22 and 26 strike prices. The premium paid in a long butterfly of a net 33 cent cost to the investor who would make 1.67 in the event that at expiration the share price of the ETF was precisely $24.00 (the central strike price). In the meantime, the retail fund must decline in value to $25.67 before the investor would breakeven. – SPDR S&P Retail ETF

GPS– Expectations for a revival in retail fortunes later in the summer were played out using options on The Gap. A bullish reversal on the global specialty retailer of clothing and accessories indicates that some investors have decided to ‘mind the gap.’ Shares of the moderately priced clothier have declined slightly today by less than 1% to $14.97. Hoping for a rally by expiration in August, investors sold 4,500 puts short at the August 12.5 strike price for 20 cents per contract in order to finance the purchase of 4,500 calls at the higher August 17.5 strike price for 25 cents apiece. Traders are left with a net cost of one nickel for the transaction and are hoping to see Gap’s shares surge 17% to the breakeven point at $17.55 by expiration. We note that shares of the stock breached $18.50 back on June 1, 2009. – The Gap, Inc.

XLP – The consumer staples ETF caught our eye this morning after we observed one far-term bullish investor purchasing a large chunk of married puts. The price of the underlying shares has risen slightly by less than 0.5% to stand at $23.13. It appears that the trader bought 9,000 put options at the December 24 strike price for a premium of 1.90 per contract. The investor simultaneously bought an equivalent number of shares of the fund for approximately $23.15 each. The investor clearly wants the share price to rally in the staples ETF, but feels the need for training wheels perhaps over worries that the current market correction turns out to provide a bigger buying opportunity. This long stock position is protected by the put options in the event that shares are trading beneath the breakeven point to the downside at $22.10 through the year end. Finally, the investor will begin to amass profits to the upside if shares rise by more than the price paid for the underlying shares plus the premium paid for the protective put options for an effective breakeven point to the upside at $25.05. – Consumer Staples Select Sector SPDR

WFC– Shares of Wells Fargo have surrendered more than 3.5% today to stand at $22.52. The WFC ticker symbol surged to command one of the top spots on our ‘most active by options volume’ market scanner after one fervent bear juggled 155,000 put options around the July and August contracts. This investor was seen rolling 45,000 puts – which he originally bought for 2.40 each – from the in-the-money July 24 strike price for a premium of 1.30 apiece to the August 24 strike where 60,000 put options commanded a purchase price of 2.75 each. The trader then reduced the cost of the transaction by selling 50,000 puts at the August 17.5 strike price for 50 cents apiece. Maximum profits will be realized by the investor if shares decline to $17.50 by expiration next month. – Wells Fargo & Co.

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