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VIX-Investor Enacts Ratio Call Spread on Fear-Gauge

Today’s tickers: VIX, JPM, PEP, MDVN, TEX, EWZ, COST, RSH, AMAG & TIVO

VIX – CBOE Volatility index – The fear-gauge spent the better portion of the session in the red, but edged higher in late-afternoon trading to stand up 1.20% to 19.29. Options players busily populated the VIX with a number of interesting trades during the session. One transaction in particular, however, focused our attention on activity in the May contract. A hefty ratio call spread involving a total of 30,000 call options at deeply out-of-the-money strike prices was established on the VIX today. The investor purchased 10,000 calls at the May 27.5 strike for a premium of $1.50 apiece, and sold 20,000 calls at the higher May 35 strike for $0.70 each. The net cost of the transaction is reduced to just $0.10 per contract. It is possible the investor was motivated to put on the spread because of the low cost of the trade and because of the allure of potential profits going forward. The trader appears to believe the VIX will likely breach the breakeven point on the spread at 27.60 in the next three months to expiration, but doubts the fear-gauge will explode up to the mid-30’s. Evidence to support such a scenario is abundant. First, the investor can almost taste victory because the VIX traded as high as 29.22 on February 5, 2010, which is well above the point at which he garners profits. Second, losses above and beyond the premium paid to initiate the trade seem unlikely because the Index failed to rise above 30 since early November of last year. The resistance of the volatility index at the 30-level persisted despite the drop in global markets after China waved the fear-flag by announcing plans to rein in its country’s economic growth at the end of January. Additionally, angst regarding Europe’s debt crisis and threats to the strength of the Euro were also unable to boost the VIX up above 30. The ratio call spread described above looks to be a relatively cheap way to profit from another bout of market turmoil or jump in investor uncertainty ahead of May expiration. We note that the index must rally at least 43% from its current level before the investor breaks even on the transaction at 27.60.

JPM – JPMorgan Chase & Co. – The banking institution’s shares surrendered intraday gains of about 1% over yesterday’s close and are currently trading flat at $41.62 with roughly eighty minutes remaining in the session. A bull call spread established in the June contract indicates one investor is hoping for a sharp rally in the price of the underlying stock by expiration in four months time. The trader purchased 15,000 calls at the June $45 strike for an average premium of $1.32 per contract, and simultaneously shed the same number of calls at the higher June $50 strike for $0.31 apiece. The net cost of the bullish transaction amounts to $1.01 per contract. Therefore, the investor is positioned to amass maximum potential profits of $3.99 per contract for total gains of $5.985 million if JPM’s shares surge 20% from the current price to $50.00 by June expiration. JPMorgan’s shares must increase at least 10.55% to $46.01 before the trader breaks even on the transaction.

PEP – PepsiCo, Inc. – Beverage and snack manufacturer, PepsiCo, ushered in bullish options traders today perhaps after analysts at Goldman Sachs Group resumed their ‘buy’ rating on the stock with a target share price of $75.00. Pepsi’s shares increased 0.55% during the session to $64.15, which is a scant $0.33 less than its current 52-week high of $64.48 attained back on December 7, 2009. Near-term optimistic traders quenched their thirst for call options by purchasing 5,100 contracts at the March $65 strike for an average premium of $0.50 apiece. Call-buyers profit if Pepsi’s shares rally another 2.10% to surpass the breakeven price of $65.50 by expiration day. Longer-term bullish sentiment appeared in the October contract where one investor initiated a risk reversal by selling put options to finance the purchase of calls. The trader sold approximately 1,100 puts at the October $60 strike for a premium of $2.55 apiece in order to buy roughly the same number of calls at the higher October $67.5 strike for $2.00 each. The investor pockets a net credit of $0.55 per contract on the reversal play, and keeps the full credit if PEP’s shares trade above $60.00 through expiration day in October. Additional profits accumulate should shares of the underlying stock rally 5.20% to trade above $67.50 in the next eight months to expiration.

MDVN – Medivation, Inc. – The failure of Dimebon, Pfizer and Medivation’s experimental drug for Alzheimer’s disease, to benefit patients in an advanced study sent MDVN’s shares reeling toward rock-bottom today. The drug’s disappointing results inspired a rash of analyst downgrades on Medivation and pushed shares down 67.80% to $12.96. The biopharmaceutical company was cut to ‘hold’ from ‘buy’ and received a twelve month target share price of $10.00 at Roth Capital, which is just one of many downgrades announced thus far today. Options trading patterns reveal mixed sentiment on Medivation, particularly in the heavily populated March contract. Contrarian players betting on a recovery in the price of the underlying stock by expiration purchased 3,200 in-the-money calls at the March $12.5 strike for an average premium of $1.26 apiece. The higher March $15 strike had more buying interest, with 6,200 call options picked up for a premium of $0.43 each. Call-selling outweighed buying at the higher March $17.5 strike price where 5,600 calls were shed for an average premium of $0.11 per contract. Perhaps traders purchasing calls believe the price of Medivation’s shares has bottomed out at present. Options implied volatility fell off the proverbial cliff following the Dimebon news and is currently down 68% to 81.31%.

TEX – Terex Corp. – Bullish option traders picked up the haunting aroma of a rally today as shares of global equipment manufacturer, Terex Corporation, jumped 8.20% to $21.62. Investors wasted little time populating TEX with optimistic positioning at the start of the trading session. Plain-vanilla in-the-money call buying took place at the March $20 strike where 2,400 contracts were picked up for an average premium of $0.94 each. Approximately 1,500 in-the-money calls were coveted at the higher March $21 strike for $0.61 apiece, while 1,000 out-of-the-money call options were purchased at the March $23 strike for an average premium of $0.22 per contract. Bulls also frequented the April $22 strike where 1,000 contracts were purchased at an average premium of $0.79 each. Uber-bullish individuals picked up nearly 2,000 lots at the higher April $24 strike for $0.31 per contract. Investors long the April $24 strike calls stand ready to amass profits if Terex’s shares surge 12.45% from the current price of $21.62, to surpass the effective breakeven point at $24.31 by expiration day next month.

EWZ – iShares MSCI Brazil Index ETF – Shares of the EWZ, an exchange-traded fund which tracks the price and performance of securities traded in the Brazilian market as measured by the MSCI Brazil index, increased 1.90% to $71.82 today. Despite the rally in the price of the underlying stock, one options player initiated a bearish risk reversal in the June contract. The investor sold 6,000 calls at the June $85 strike for a premium of $0.75 each in order to partially finance the purchase of 6,000 puts at the lower June $65 strike for $2.52 apiece. The net cost of the reversal amounts to $1.77 per contract, and positions the investor to accumulate profits should shares trade below the breakeven price of $63.23 by expiration in June. If the trader is long shares of the underlying fund, the puts serve to protect the value of the position should shares decline, and the short calls mimic a covered-call stance. However, if the investor does not hold an equivalent number of EWZ shares, the naked selling of call options at the June $85 strike exposes the trader to potentially devastating losses in the event of a sudden surge in shares ahead of expiration.

COST – Costco Wholesale Corp. – The largest warehouse-club chain in the United States posted a 25% increase in second-quarter profit to secure earnings of $0.67 per share up from $0.55 a share one year earlier. Shares are trading slightly lower by 0.70% to $60.95, however, and inspired one investor to initiate a protective put play in the April contract. The trader enacted a ratio put spread by purchasing roughly 2,000 contracts at the April $60 strike for an average premium of $1.11 apiece, marked against the sale of approximately 4,000 put options at the lower April $57.5 strike for $0.45 each. The net cost of the spread amounts to $0.21 per contract. If the investor is long shares of the underlying stock, the put spread serves to protect the value of the position should Costco’s shares trade below the breakeven point at $59.79 ahead of expiration day. Options implied volatility contracted 16.77% to 16.67% following earnings.

RSH – RadioShack Corp. – The retailer of consumer electronic products attracted droves of bullish investors in the first hour of the trading session with shares of the underlying stock up 5.50% to $20.96. RadioShack options optimists attempting to sate their hunger for calls exchanged more than 11.7 call contracts for each single put option in play thus far in the trading day. Investors purchased at least 6,000 in-the-money calls at the March $20 strike for an average premium of $0.65 apiece, while the higher March $22.5 strike had 2,000 contracts picked up for a premium of $0.13 each. Optimistic trading patterns spread to the April contract where another 2,700 calls were coveted at the April $22.5 strike for an average premium of $0.46 per contract. Call buyers positioning for continued bullish momentum in RadioShack’s share price lifted the overall reading of options implied volatility on the stock up 25.88% to 41.24% as of 11:00 am (ET).

AMAG – AMAG Pharmaceuticals, Inc. – Bearish options activity ensued in morning trading after shares of the biopharmaceutical firm slipped 3.60% to $33.86. One investor initiated a credit spread in the April contract to attempt to profit from AMAG’s pain. The trader sold 3,000 calls at the April $37.5 strike for $1.35 apiece, and purchased the same number of calls at the higher April $42.5 strike for $0.35 each. The investor pockets a net credit of $1.00 per contract on the spread, which he keeps if AMAG’s shares trade below $37.50 through April expiration. The trader is exposed to maximum potential losses of $4.00 per contract should the firm’s share price rebound up to $42.50 by expiration day.

TIVO – TiVo, Inc. – Shares of the producer of digital video recorders are up 3.20% to $10.35 in early trading on optimism regarding the firm’s new product, TiVo Premiere, which facilitates access to TV programming, movies, Web videos, music and even Pandora Internet radio. Investors initiated bullish options plays on the stock right out of the gate this morning. One trader extended a bullish position on TIVO by rolling a large chunk of call options to a higher strike price. The investor sold 5,000 in-the-money calls at the March $10 strike for a premium of $1.05 apiece in order to roll the position to the higher April $11 strike, where he paid an average premium of $1.40 per contract for 5,000 call options. The net cost of the transaction – in isolation – amounts to $0.35 per contract, and positions the investor to accumulate profits if TIVO’s shares trade above $11.35 by April expiration.


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