Trade of the Day: Brazil July $72/$76 ratio call spread

The Trade:
A trader set up the July $72/$76 ratio call spread, 7,000x14,000, at a $1.04 debit.

Options 101: The 1x2 Ratio Call Spread (front spread)

A ratio 1x2 call spread, or front spread, is comprised of 2 legs, both calls at two different strike prices in the same expiration month. Ratio spreads involve buying one option and selling two options with a higher strike price. The most common ratio is 1x2, but any ratio can be used. Ratio spreads can be executed for debits, credits, or even money. Ratio spreads can be very complex, which increases the amount of risk involved.

Trade of the Day: Target May $49/$47 ratio put spread 2,500x5,000

The Trade

A trader sold 5,000 May $47 puts at $0.74 and bought 2,500 May $49 puts at $1.48 at no cost to the trader.

Trade of the Day: PCS March 12/13 1,600x2,500 call spread

The Trade

A trader bought 1,600 March $12 calls at $1.55 and sold 2,500 March $13 calls at $0.90 for a debit of $23,000.

Risk/Reward

As you can see from the graph above, the front spread has unlimited risk and limited profit potential. The downside risk is limited to the debit, but the upside risk is unlimited. At expiration, the maximum profit of $137,000 occurs at an underlying price of $13. At this price level, the long calls would be exercised and the short calls would expire worthless. It's interesting to note that at the time of execution, the $13 calls were in the money. The lower and upper break even prices for this spread at expiration are $12.14 and $14.52.

The two lines shown above are the lower and upper break even underlying prices.

MetroPCS Communications, Inc. offers wireless broadband mobile services in selected metropolitan areas in the United States over its own licensed networks or networks of entities. PCS will report quarterly earnings before the open on February 24, 2011. PCS traded 6,066 contracts compared to daily average volume of 1,075.

According to Google Finance, PCS has the highest Price-to-sales ration of 1.36 compared to competitors 0.96 for VZ, 0.92 for S, and 1.35 for T.

Trade Idea: HPQ March 47/45 1x2 put spread

The Trade

CNBC's Options Action recommended a trade with HPQ. They recommended executing the March 1x2 for a $0.05 debit by buying 1 March $47 put and selling 2 March $45 puts.

Risk/Reward

As you can see from the graph above, the put front spread is bearish with a bias to an underlying price of $45 at expiration. The max risk is $4,305 if the stock goes to zero. The max profit potential for this spread is $195 with the HPQ at $45. At an underlying price of $45, the short puts would expire worthless, and our long puts would be exercised. The break even price of the spread is at $46.95. At expiration, if the underlying is above $47, the spread would lose only its debit as both options would expire worthless.

The line above shows the break even price level at expiration.

Hewlett-Packard Company is a provider of products, technologies, software, solutions and services to individual consumers, small and medium sized businesses. HPQ releases earnings on February 22, 2011. HPQ traded 40,820 contracts today compared to average daily volume of 41,679. The 52-week range for HPQ is a low of $37.32 and a high of $54.75.

Trade: C September $5.5/$6 front spread 1x2

The Trade

A trader bought 50,000 September $5.5 calls at $0.22 and sold 100,000 September $6 calls at $0.12 for a credit of $0.02 or $100,000.

Risk/Reward

As you can see from the risk/reward graph above, the front spread has unlimited risk to the upside and limited profit potential. The unlimited risk is caused by being naked short the higher strike calls. The max gain would occur at an underlying price of $6. At an underlying price of $6, the short calls would expire worthless, and our long calls would be intrinsically worth $0.50 per contract.

The daily chart above shows C dating back to March 2009. At September expiration, the spread would be profitable for any underlying price below $6.52. The 52-week range for C is a low of $3.15 and a high of $5.15.

It's interesting to note that hedge fund manager, David Tepper, raised his Citigroup Inc. stake by 73% in the fourth quarter. Tepper's Appaloosa Management LP's holdings in Citigroup rose to 138.1 million common shares at December 31 from 79.7 million shares at September 30, according to a Form 3F filed with the U.S. Securities and Exchange Commission. Appaloosa also increased their stake in Bank of America, Wells Fargo, and JPMorgan Chase.

A September $5/$5.5 front spread 18,000x36,000 for a credit of $0.03 also traded today.

Option Flow Recap for Febuary 9 2011

Macro / Thematic

IWM – 30,000 of the April 72 puts were bought for $0.95 to open.

GDX – 10,000 of the February11 (weekly) / February (regular expiration) 57 call spread was bought for $0.43. The weekly option appeared sold at $0.25 to open and the regular February option appeared bought for $0.68 to open. The investor is betting the shares of GDX remain below 57 for the rest of the week before moving higher into next week’s expiration.

FXI - 7,500 Feb 41/42 put sreads bot to open

EEM - 20,000 May 36 puts sold @ .40 10,000 April 43 puts bought @ 1.1 (possible roll up and out)

Consumer

JCP – Over 5000 of the March 35 / 31 1x2 put spreads were bought to open as the stock hits a new 52-week high. The trade appears to be a short term hedge as the stock has made a 15.6% move over the past four days.

M – Options were active in Macy’s today with almost 20,000 calls and 7700 puts trading. Most of the early action was bullish with call buyers active in the February 25 and 26 calls.

SCSS – An investor sold 6000 June 7.50 puts at 0.275

F – 15,000 March / May 17 call spreads traded for $0.48. The trade appears to be a roll out two months.

SLE – 17,000 March 17 puts appeared bought today (99% traded on the offer). The company’s stock has been under pressure since the company announced that it was planning to split into separate companies rather than put itself up for sale.

BBBY - 1500 March 50 calls bought at $1.18

Energy

EPD – Bearish trade in Enterprise Products Partners where May 40 - 44 bullish risk reversal, bought at 40 cents, 3800x after news of a fire at a Houston plant.

SOLR – February 10 calls were active today with 6500 trading on the day. While early action appeared to be call buyers, the overall action appeared to be both ways.

PPL – 800 July 24 puts were sold to open at $1.05

HNP – 700 March 22.5 calls were sold $0.30.

TMT

ATML – Bullish post earnings trade: 25,000 lot block of May 17 calls bought for 1.40 versus a sale of 15,000 Feb 13 calls for 3.40.

NOK – 6000 July 10 / 8 put spreads were bought for $0.275

ALU – February 3.5 calls are active today with 7800 trading. The company reports tomorrow 2/10.

NTAP – 8000 of the February 65 calls appeared sold at $0.35. earnings on 2/16

YHOO – 10,000 April 17 / Jan 17.5 call spread was bought for $1.10,

Industrials / Materials

USG - An investor apparently sold 2,250 February 17.5 calls at $1.425 to appear to buy to open a May 19 / 22.5 calls spread for $1.30

PCX – 4000 March 25 calls were bought for $1.40

YRCW – 37,000 April 2.5 puts were bought for $0.27. The puts were bought to open

Financials

CBOE – Speculative call buying was active in CBOE following news the NYSE Euronext (NYX) and Deutsche Boerse are in advance merger talks. Almost 15,000 calls and 5000 puts traded on the day. 

KFN - Buyer of 3k March 10 calls @ $0.60 and 5k March 11 calls @ $0.20

Healthcare

THC – Over 5000 of the March 7 calls appeared bought in a multi exchange sweep.

*Special thanks to Option Radar, BMO Capital, LiveVolPro, CBOE, Option Monster, and all of the options desks and traders we work with for pointing out the option flow!

Trade of the Day: JPM Jan 2012 40/30 ratio put spread

The Trade

Today, a trader bought 25,000 Jan 2012 40 puts @ 3.05 and sold 50,000 Jan 2012 30 puts @ 0.95 for a net debit of 2,875,000.

Risk/Reward

As you can see from the risk/reward graph above, the ratio put spread has limited risk and limited profit potential, with a bearish bias. The maximum risk for this spread would occur if the underlying stock goes to zero. The maximum risk would therefore be $52,875,000 in this situation. The max profit for the spread would occur at an underlying stock price of $30. At this price level, the short puts would expire worthless, and the long puts would be exercised. The max profit would therefore be $22,125,000. The break even price level in the underlying stock is 38.85, which is the higher strike price minus the debit. Ratio put spreads are a popular and cheaper way to hedge long stock vs buying a put vertical as long as the trader understands the increased risk/reward profile.

This bearish ratio put spread would be profitable if the underlying stock went below $38.85. JPM last dipped below the $39 level in November of 2009. It's interesting to note that JP Morgan hosts an analyst day on the 14th of February.