Are Big Call Buys Necessarily Bullish Plays?

04/29/2010 12:01 am EST

Focus: OPTIONS

Jud Pyle

Chief Investment Strategist, ONN.tv

Louisiana-Pacific Corp. (NYSE: LPX) shares finished Tuesday down more than 5% to $11.93. The company’s earnings figures are due on May 10 before the market opens. Options action during afternoon trading suggests investors expect significant upside in LPX shares during the next four months and are willing to risk a sizeable amount on that bullish bet. It’s worth noting that LPX is in the business of supplying products for new homes, primarily ones that rely on lumber and wood production. Jared Levy wrote about that sector just this week.


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Around 3:21 pm ET on Tuesday, 12,000 out-of-the-money August 17.50 calls changed hands for a premium of roughly 35 cents per contract versus current open interest of zero contracts, indicating these options were initiated to open. While this trade seems very bullish at first glance, it is possible that the investor traded these options with stock, meaning the call buyer simultaneously sold shares to the option market maker. The fact that the investors executed a delta-neutral trade could mean they are more interested in betting on volatility than direction. The August 17.50 calls closed with an implied volatility of 56% compared to the stock’s 30-day historical volatility of 50%. If the investor thinks LPX will make an unusual move after the company’s earnings announcement, then purchasing options on an implied volatility of 56% will make money if the trade is hedged daily until expiration. I like to use my virtual trading account to look at the profit and loss potential for trades like this delta-neutral call.

I think, however, that this trade is bullish because the investor has sold the stock to the option market makers to control the price jump in the stock caused by market makers buying the stock in the open market. This play allows investors to purchase volatility from the market makers rather than delta. Not only does the investor get a cheaper options price because option market makers do not have the take stock price risk at the time of the option sale, but the action also allows the investor to keep the purchase of the stock more anonymous. The investor may have bought the stock in the market prior to buying the calls, hoping that the price paid for the shares will be less than what would be implied in the option price. The investor then sells the stock to the market makers and is left with the long calls.

By Jud Pyle of ONN.tv

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