Good Example of a Short Strangle Option Trade

09/30/2010 12:01 am EST


Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Speculation has been rampant on Morgan Stanley (MS) this week after rumors surfaced late Monday that the firm was considering layoffs and bonus cuts. On Tuesday morning, more than 6,400 calls and 6,800 puts have changed hands on this financial concern, though two rather large blocks stand out from the rest.

Diving into the options activity, one trader established a short strangle by selling 4,000 November 24 puts for the bid price of $1.15 and simultaneously selling 4,000 November 26 calls for the bid price of $0.71. The result is a net credit of $1.86, or $186 per contract. For those unwilling to do the math, that's a cool $744,000 in the bank for this speculative trader. Today's short strangle play on Morgan Stanley echoes a near-identical trade that crossed the tape on Monday, as reported by Sarah Wasserman.

In order to retain this credit, the trader needs MS to remain between $24 per share and $26 per share through Nov. 19, when the options expire. Outside those bounds, the trader can retain some of the initial credit if MS closes above the lower break-even rail of $22.14 per share, or below the upper break-even level of $27.86 per share. Below is a visual representation of the trade:

Click to Enlarge

By Joseph Hargett, contributor, Schaeffer’s Trading Floor Blog

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