A Debit Spread Option Trading Strategy

04/08/2010 12:01 am EST

Focus: OPTIONS

Elizabeth Harrow

Financial Analyst, Schaeffer's Investment Research, Inc.

Regions Financial Corporation (RF) was the target of a bearishly biased option strategy today, with one speculator betting on a near-term decline for the banking issue.

RF price chartShortly after the open, two blocks totaling 2,819 contracts traded on RF's May 8 put at the ask price, suggesting they were purchased. Simultaneously, two matching blocks totaling 2,819 contracts changed hands on the stock's May 7 put near the bid price, revealing they were most likely sold.

By initiating this long put spread, the speculator is looking for RF to drop below $8 per share by the time May-dated options expire. The sale of the May 7 puts effectively lowers the cost of entry on the trade, but it also severely limits the speculator's profit potential. The trader's maximum gain is limited to the one-point spread between the two strike prices, less the initial net debit.

In the best-case scenario for this debit spread strategist, RF will settle squarely at $7 upon May expiration. This will reap the maximum profit on the purchased puts, while the sold puts can be left to expire worthless.

This bearishly biased option strategy reveals some defiant skepticism in the face of RF's recently positive price action. The shares have galloped to a gain of 54.8% in 2010, and as a result, the equity's formerly resistant ten- and 20-month moving averages have been pulled to the verge of a bullish cross.

In Tuesday’s trading, RF touched a new annual high of $8.81 early, buoyed by a price-target boost from Credit Suisse. The brokerage upped its target for the stock from $7 to $8, aligning perfectly with the strikes used to build today's debit spread.

By Elizabeth Harrow of Schaeffer’s Trading Floor Blog

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