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Caterpillar Optimist Buys Bullish Risk Reversal

Today’s tickers: CAT, EEM, CHK, AAPL, AA, UUP, MNKD, LVLT, CHTT, WTR & WAG

CAT – Caterpillar, Inc. – Near-term bullish options trading on the machinery manufacturer today suggests some investors are positioning for a rally in CAT shares by expiration day in January 2010. The stock edged 0.75% higher during the trading session to $57.56. One investor initiated a bullish risk reversal on Caterpillar by selling 6,000 puts at the January 55 strike for a premium of 95 cents each, spread against the purchase of 6,000 calls at the now in-the-money January 57.5 strike for 1.67 apiece. The net cost of the reversal play amounts to 72 cents per contract. The investor accumulates profits on the transaction if CAT’s shares rally above the breakeven price of $58.22 by expiration.

EEM – iShares MSCI Emerging Markets Index ETF – Shares of the emerging markets exchange-traded fund increased 0.10% today to $40.41. Option traders established long-term bullish and long-term bearish positions in the January 2012 contract during the session. A bullish risk reversal took place at the January 2012 40 strike where one trader sold 6,500 puts for 7.80 apiece to buy 6,500 calls for 7.50 each. The optimistic investor pockets a net credit of 30 cents per contract on the transaction. The full 30 cent credit is safe in the trader’s piggy bank if shares of the EEM trade at or above $40.00 through expiration in two years. The investor is positioned to accrue additional profits as shares increase above $40.00. The other transaction observed in the January 2012 contract appears to be bearish. The trade involved the sale of 10,000 calls at the January 2012 45 strike for a premium of 5.30 each, marked against the purchase of 5,000 puts at the January 2012 35 strike for 5.50 each. The investor takes in a net credit of 5.10 per contract due to the 2-to-1 ratio of calls sold to puts purchased. EEM’s shares must trade below $45.00 in order for the investor to keep the 5.10 credit.

CHK – Chesapeake Energy Corp. – Natural gas and oil exploration and production company, Chesapeake Energy Corp., experienced a 1.75% rally in the price of its shares to stand at $26.52 in afternoon trading. Some investors are anticipating a significantly higher share price for CHK by expiration in July 2010. Chesapeake-bulls bought roughly 4,000 calls at the July 30 strike for an average premium of 1.86 per contract. Call-buyers stand ready to accrue profits if CHK’s shares rally at least 20% from the current price to surpass the effective breakeven point at $31.86 by expiration. We note that Chesapeake’s shares have remained below $32.00 since October 1, 2008.

AAPL – Apple, Inc. – The iPod manufacturer’s shares are up 1.75% this afternoon to $198.74, but bullish options activity on the stock today suggests shares may rally significantly by expiration in April 2010. A ratio call spread was enacted through the purchase of 1,600 calls at the April 200 strike for an average premium of 15.56 each, marked against the sale of 3,200 calls at the higher April 230 strike for 5.25 apiece. The net cost of the spread amounts to 5.06 per contract. Maximum potential profits of 24.94 are available to the trader if Apple’s shares rally 16% to $230.00 by expiration day. The investor breaks even on the trade if shares increase 3.2% to the breakeven price of $205.06 within the next four months.

AA – Alcoa Inc. – A double-whammy of positive news on top of an already buoyant stock market saw investors forge gains of 9% to $15.90 for shares of Alcoa in early trading on Monday. The stock suddenly looks comfortable above $15 for the first time this year. The company announced a $10.8 billion joint-venture with a Saudi mining company in which the two companies would develop an aluminum industrial complex in Saudi Arabia. Investors are clearly putting stock in the words of Alcoa’s CEO who referred to a change in the operating dynamics and cost base within the aluminum industry. Broker Morgan Stanley also upgraded its status to “buy.” In examining today’s most active options on the stock it appears that one trader was already positioned for an improvement in the prospects for Alcoa. Some 13,000 call options reserving buying rights before they expire in January at the fixed strike price of $15 were sold for a $1.30 premium. With substantial open interest already present at the strike it’s of interest to us that these calls traded through the bid price at what was a deep in-the-money option at the time. It appears that this investor read the prospects for Alcoa pretty well. Those call options just about doubled in today’s trading and earlier this month traded at as low as 20 cents per contract.

UUP – PowerShares DB US Dollar Index Bull ETF – With the exception of a weak performance against an inspired Canadian dollar, the U.S. dollar is up across the board, although not so that you’d know it according to a marginally changed dollar index. Yet we continue to see heavy volume in the PowerShares ETF where option traders have recently made significant trades in the expectation that the dollar might rise. With the ETF trading at $23.02 today the most heavily trafficked call option series is at the 23 strike where investors over recent weeks have amassed positions amassing to a reading of open interest of some 469,000 contracts. In today’s action in which the UUP is one of the most active, it appears that investors are closing out some long call positions by selling out profitable plays. The calls appear to be trading largely to the 55 cent bid and the volume is buoyant despite the fact that the dollar index is not going anywhere today. Having said that the ongoing rise in yields is a comfort to investors hoping the dollar will trade higher. At 4.63% the 10-year yield looks set to breach overhead resistance that could see another 20 basis points on yield pretty quickly. The UUP was trading at $22.05 just three weeks ago.

MNKD – MannKind Corp. – Bearish option traders populated biopharmaceutical company, MannKind Corp., today with shares of the firm up a slight 0.10% to $9.32. Investors threw in the towel on out-of-the-money calls in the February contract and initiated pessimistic trades using in-the-money calls. Approximately 3,600 calls were sold at the February 12.5 strike for one dollar per contract. Open interest at that strike of 6,381 contracts suggests the sale of the calls is likely the work of traders abandoning previously established bullish positions on MNKD. Meanwhile, investors expecting shares of the biotech company to move substantially lower by expiration in February, sold roughly 7,000 in-the-money calls at the February 7.5 strike for an average premium of 1.97 apiece. Option implied volatility on the stock fell 26% during the first half of the session, from an intraday high of 125.94%, to the current reading of 99.90%.

LVLT – Level 3 Communications, Inc. – The fixed line telecommunications firm suffered a 2.75% decline in the value of its shares today to arrive at the current price of $1.42. LVLT appeared on our ‘hot by options volume’ market scanner after one investor dabbled in put options on the stock. It looks like the trader rolled a long put position in the near-term January contract out to the June 2010 contract. The investor likely sold 7,900 puts at the in-the-money January 2.5 strike for a premium of 1.05 apiece in order to buy the same number of puts at the June 2.5 strike for 1.15 each. It is unclear how much the investor initially paid for the January 2.5 strike put options. However, the trader could be banking gains on the original bearish stance given the in-the-money status of the puts today. The net cost of the calendar roll – in isolation – amounts to 10 cents per contract, and positions the trader to amass profits to the downside beneath the breakeven point at $2.40.

CHTT – Chattem, Inc. – Shares of the manufacturer of branded over-the-counter healthcare products jumped 32.5% this morning to $92.84 after French drug maker, Sanofi-Aventis, revealed plans to buy Chattem for about $1.9 billion. Option traders exchanged more than 12,300 contracts on CHTT as of 10:10 am (EDT), which exceeds existing open interest on the stock of 10,916 lots. Investors appear to be favoring call options over puts on Chattem by a factor of roughly 1.5-to-1.

WTR – Aqua America, Inc. – Option implied volatility is up sharply on the holding company for regulated utilities, which provide water or wastewater services to customers in the United States. WTR’s reading of option implied volatility rose 26.80% to 22.45%. Perhaps the increase in volatility stems from investor call-buying activity in the March 2010 contract. It looks like traders bought approximately 3,000 calls at the now at-the-money March 17.5 strike for an average premium of 80 cents each. Aqua America’s shares are up 1.25% this morning to $17.50.

WAG – Walgreen Co. – The drug store chain’s shares improved 1% in early morning trading on news the firm posted a 20% increase in first-quarter profit to earn 49 cents per share. But, shares are lower by more than 1% to stand at $36.25 as of 10:20 am (EDT). Option traders exchanged nearly 19,000 contracts on the stock within the first hour of the trading session. Option implied volatility contracted 17.07% to 27.07% following earnings.

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