Wednesday, February 2, 2011

Trade of the Day: C June 5.5/6 bull vertical

The Trade
Today, a trader bought 125,000 June 5.5 calls @ 0.16 and sold 125,000 June 6 calls @ .07 for a net debit of .09 or $1,125,000.

As you can see from the risk/reward graph above, the bull vertical has limited risk and limited profit potential. The maximum loss for this spread is the debit. The max profit for this bull vertical would be $5,125,000. The break even price level in the underlying stock is 5.59, which is the long call strike plus the debit.

Citigroup's 52-week high is $5.15. Therefore, for this bull vertical to be profitable, Citigroup would have to make new highs. I would describe the buyer of this spread to be very ambitious because as we can see from the chart above, the $5 level has proven to be a strong resistance level. It is important to remember that most mutual funds cannot own stocks under $5. Therefore, if C can hold above $5 for a week or more, mutual funds might take long term positions in the name.

Alternative Trade
The June 5-6-7 long butterfly for a debit of 0.18 (taking liquidity at the close today).

As you can see, this trade breaks even between $5.15 and $6.85. Although the debit is twice as much as the "Trade of the Day" the break even is .44 lower. The butterfly is also short vega, theta, and gamma. If C does move to $6 being short vega and theta will most likely be a positive. The down side to the the butterfly is the short gamma but only if C runs quickly though $7 without looking back. The butterfly should therefore be unwound when C is trading at or near $6.

Feel free to comment if you have any questions.

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