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Friday, July 23, 2010 7:51:28 PM
Options Trade of the Day: Post-Earnings Synthetic Short on Yahoo! Inc.
Options trader bets on a sharp decline for this Internet portal concern
by Joseph Hargett (jhargett@sir-inc.com) 7/23/2010 4:20 PM
On July 21, Yahoo! Inc. (YHOO) released its second-quarter earnings figures to a chorus of boos from investors. The stock plunged more than 8% following the report, with losses extending through today's annual low of $13.52 per share. YHOO finds itself on the wrong side of long-term support in the 14-14.50 region, an area the shares have not closed a week below since April 2009.
As you would expect, options activity is starting to pick up on YHOO, especially on the put front. Nearly 14,000 of these bearishly oriented contracts have changed hands on YHOO today. In particular, options traders are focused on the August 14 strike, where more than 8,000 puts have changed hands so far.
While the August 14 strike has been the most actively traded, there was a much more interesting trade at the August 15 strike. Specifically, a block of 400 contracts traded at the ask price of $1.27 on the International Securities Exchange (ISE) at about 11:35 a.m. Eastern time. This block was marked "spread." The other half of this trade crossed on the August 15 call, where a block of 400 contracts traded at the same time on the same exchange for the bid price of $0.12. Given this data, it would appear that we are looking at a synthetic short position on Yahoo!.
The Anatomy of a Yahoo! Inc. Synthetic Short
Before we get into the particulars, a synthetic short options trade attempts to replicate as closely as possible a short stock position. The trader buys at-the-money puts and sells at-the-money calls in equal numbers at the same strike with the same expiration date. By using options, the trader gains considerable leverage, allowing for greater returns on the position than those that would be achieved by investing the same amount of money in a short stock position.
This particular synthetic short on YHOO breaks down as follows: The trader bought 400 YHOO August 15 puts for the ask price of $1.27. The total debit incurred for entering this position would be $50,800 -- (1.27 * 100) * 400 = $50,800. At the same time, the trader sold 400 August 15 calls for the bid price of $0.12. The total credit for entering this leg of the position arrives at $4,800 -- (0.12 * 100) * 400 = $4,800. Combining this leg of the trade with the purchased August 15 put results in a net debit of $46,000-- $50,800 - $4,800 = -$46,000 -- plus brokerage fees and margin requirements.
The maximum profit on this trade is equal to the purchased put strike minus the debit paid upon entering the position. Since the initiation of the trade resulted in a debit of $1.15, the maximum profit is $13.85, or $1,385 per contract -- $15 - 1.15 = $39.64. Since there is no cap to how high YHOO shares can rally, the potential losses are theoretically unlimited. Breakeven, meanwhile, is calculated by subtracting the net debit from the strike price of the purchased August 15 put, and arrives at $13.85. Below is a chart for a rough visual representation of the trade's profit/loss scenario:
Implied Volatility
Rising implied volatility is pretty neutral for a synthetic short trade. It lifts the value of both the purchased and the sold options, thus increasing the cost to buy back the sold call and boosting the premium received when selling the purchased put. At the time of the trade, implied volatility for the YHOO August 15 call rested at 30.38%, while implieds for the August 15 put were 31.72%. The stock's one-month historical volatility rested at 43.31% as of the close on Thursday.
Final Thoughts
On a final note, let's run a quick comparison to see the difference between a synthetic short option position and a short stock trade. For this example, assume that Trader Bob sold 100 shares of YHOO short for $15 each, the credit being $1,500 (excluding margin requirements and broker fees). Meanwhile, Trader Joe sold one August 15 call and bought one August 15 put, resulting in a debit of $1.15, or $115 per contract (again, excluding margin requirements and broker fees). Both traders control 100 shares of YHOO, but Trader Bob pocketed $1,500 while Trader Joe had to pay $115.
Let's say that YHOO closes at $13 per share on August expiration. If Trader Bob closes out his entire position, he would earn $2 per share, resulting in a profit of $200. For Trader Joe, the August 15 call would expire worthless, while the August 15 put would be worth $2. As a result, Trader Joe would earn $2 minus his initial debit of $1.15, bringing his profit on the entire position to $0.85, or $85 per contract. Now, imagine if Trader Joe had risked the same amount of capital as Trader Bob, and you can see why synthetic short option trades can be quite lucrative for bearish traders.
Options trader bets on a sharp decline for this Internet portal concern
by Joseph Hargett (jhargett@sir-inc.com) 7/23/2010 4:20 PM
On July 21, Yahoo! Inc. (YHOO) released its second-quarter earnings figures to a chorus of boos from investors. The stock plunged more than 8% following the report, with losses extending through today's annual low of $13.52 per share. YHOO finds itself on the wrong side of long-term support in the 14-14.50 region, an area the shares have not closed a week below since April 2009.
As you would expect, options activity is starting to pick up on YHOO, especially on the put front. Nearly 14,000 of these bearishly oriented contracts have changed hands on YHOO today. In particular, options traders are focused on the August 14 strike, where more than 8,000 puts have changed hands so far.
While the August 14 strike has been the most actively traded, there was a much more interesting trade at the August 15 strike. Specifically, a block of 400 contracts traded at the ask price of $1.27 on the International Securities Exchange (ISE) at about 11:35 a.m. Eastern time. This block was marked "spread." The other half of this trade crossed on the August 15 call, where a block of 400 contracts traded at the same time on the same exchange for the bid price of $0.12. Given this data, it would appear that we are looking at a synthetic short position on Yahoo!.
The Anatomy of a Yahoo! Inc. Synthetic Short
Before we get into the particulars, a synthetic short options trade attempts to replicate as closely as possible a short stock position. The trader buys at-the-money puts and sells at-the-money calls in equal numbers at the same strike with the same expiration date. By using options, the trader gains considerable leverage, allowing for greater returns on the position than those that would be achieved by investing the same amount of money in a short stock position.
This particular synthetic short on YHOO breaks down as follows: The trader bought 400 YHOO August 15 puts for the ask price of $1.27. The total debit incurred for entering this position would be $50,800 -- (1.27 * 100) * 400 = $50,800. At the same time, the trader sold 400 August 15 calls for the bid price of $0.12. The total credit for entering this leg of the position arrives at $4,800 -- (0.12 * 100) * 400 = $4,800. Combining this leg of the trade with the purchased August 15 put results in a net debit of $46,000-- $50,800 - $4,800 = -$46,000 -- plus brokerage fees and margin requirements.
The maximum profit on this trade is equal to the purchased put strike minus the debit paid upon entering the position. Since the initiation of the trade resulted in a debit of $1.15, the maximum profit is $13.85, or $1,385 per contract -- $15 - 1.15 = $39.64. Since there is no cap to how high YHOO shares can rally, the potential losses are theoretically unlimited. Breakeven, meanwhile, is calculated by subtracting the net debit from the strike price of the purchased August 15 put, and arrives at $13.85. Below is a chart for a rough visual representation of the trade's profit/loss scenario:
Implied Volatility
Rising implied volatility is pretty neutral for a synthetic short trade. It lifts the value of both the purchased and the sold options, thus increasing the cost to buy back the sold call and boosting the premium received when selling the purchased put. At the time of the trade, implied volatility for the YHOO August 15 call rested at 30.38%, while implieds for the August 15 put were 31.72%. The stock's one-month historical volatility rested at 43.31% as of the close on Thursday.
Final Thoughts
On a final note, let's run a quick comparison to see the difference between a synthetic short option position and a short stock trade. For this example, assume that Trader Bob sold 100 shares of YHOO short for $15 each, the credit being $1,500 (excluding margin requirements and broker fees). Meanwhile, Trader Joe sold one August 15 call and bought one August 15 put, resulting in a debit of $1.15, or $115 per contract (again, excluding margin requirements and broker fees). Both traders control 100 shares of YHOO, but Trader Bob pocketed $1,500 while Trader Joe had to pay $115.
Let's say that YHOO closes at $13 per share on August expiration. If Trader Bob closes out his entire position, he would earn $2 per share, resulting in a profit of $200. For Trader Joe, the August 15 call would expire worthless, while the August 15 put would be worth $2. As a result, Trader Joe would earn $2 minus his initial debit of $1.15, bringing his profit on the entire position to $0.85, or $85 per contract. Now, imagine if Trader Joe had risked the same amount of capital as Trader Bob, and you can see why synthetic short option trades can be quite lucrative for bearish traders.
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