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Daily Options Intelligence Report

Bears in the butterfly garden

Thu, Jul 9 2009, 05:49 GMT
by Andrew Wilkinson

Interactive Brokers LLC  |  View company's profile

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MS – Morgan Stanley – 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.

EXPE – Expedia, Inc. – 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.

FCX – Freeport-McMoran Copper & Gold, Inc. – 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.

Published on  Thu, Jul 9 2009, 05:51 GMT

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