Tuesday, February 1, 2011

Trade of the Day: CVS February 35/34 bull risk reversal

Today a trader bought 5,000 Feb 35 calls @ 0.65 and sold 6,500 Feb 34 puts @ .67 for a net credit of $110,500. As you can see from the risk/reward graph above, the ratio bull risk reversal has unlimited profit potential above $33.83 due to the credit received from the spread. The risk is being put 650,000 shares of stock if the underlying stock is trading at or below $34.

The chart above shows the break even price level for this spread at $33.83. As you can see, the break-even line has shown to be a support and resistance in the past.  It is also interesting to note that the current strike peg is $34 with expiration only 3 Fridays away.

I'd like this spread if I wouldn't mind owning the stock at 34. But why not sell the 37 calls too and collect some more premium?  Previous high is at $38; Maybe this trader sees CVS really ripping after their earnings report on 2/3/2010.  Its also important to note that there is a margin requirement for risk reversals.

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