Major Breakout in Store for Walgreen

12/20/2011 9:00 am EST

Focus: STOCKS

Mark Sebastian

Founder, OptionPit.com

Recent options activity and upcoming news and earnings all point to a strong likelihood for an upside breakout in shares of Walgreen Co. (WAG), writes Marc Sebastian of OptionPit.com.

While I usually stick to large themes like VIX and SPX, today I wanted to point toward something interesting going on in Walgreen Co. (WAG) options. Take a look at a chart of the stock performance (top) relative to the performance of implied volatility (IV) of the options (bottom chart).

chart
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Implied volatility for WAG is exploding off the charts. It is insanely high ahead of these two major events:

  1. Walgreens’ earnings will be announced tomorrow (Wednesday, December 21)
  2. A possible resolution in the Express Scripts (ESRX) battle

I have a strong suspicion that a deal is going get done with ESRX and/or earnings will impress. This is because we are in a rare occurrence where IV is going up because of bullish activity, not because of put buying.  

Below is the option trade list from last Friday (Dec. 16):

chart
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On Friday, there were two major traders that went up a Jan 30/36 risk reversal option trade with the customer buying the call and the Jan 35/39 call spread with the customer buying the 35 calls. Both of these trades are extremely bullish in nature.

The risk reversal points toward a customer that is tightly hedging a short, or more likely, setting up a smart way to get long the stock above $36 or below $30. The call spread buyer clearly thinks WAG is going to the $38.50-$40 area based on what he or she paid. The trade wins above $36, but does not clean up until above $38.

I like both these trades and followed suit. I am currently long the 36/39 call spread for around 80 cents.

Other plays that might be interesting are one-by-twos and possibly even other types of call spreads. It seems quite clear that WAG is going to move, and on paper, it looks likely to be up.

That said, at $4, the straddle could be a winner, especially if a deal fails to materialize. If that happens, we could see WAG at $28 or so.

By Marc Sebastian of OptionPit.com

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