Great Example of Long Straddle on LNKD

06/22/2011 8:00 am EST

Focus: OPTIONS

Andrea Kramer

Associate Editor, Schaeffer's Investment Research, Inc.

This bearish option straddle on LinkedIn Corporation (LNKD) will accumulate a sizable profit if the shares continue their steady post-IPO decline, while at the same time hedging against a sudden rebound.

Social networking sultan LinkedIn Corporation (LNKD) continues to suffer a post-IPO drop this week as the stock falls in sympathy with fellow Wall Street freshman Pandora Media (P).

Amid LinkedIn’s retreat, put players sent roughly 15,000 contracts across the tape at the end of last week—nearly twice LNKD's average daily volume of around 7,800 puts. For comparison, just 6,905 LNKD calls changed hands during the course of last week's Wednesday session.

Digging deeper into the data, it appears that speculators were adding new pessimistic positions at the out-of-the-money July 60 put, which saw close to 1,300 contracts traded. Seventy percent of the soon-to-be front-month puts crossed at the ask price, and put open interest at the round-number strike swelled by nearly 900 contracts overnight, confirming our suspicions of bearish buy-to-open activity. In fact, the 60 strike is now home to peak put open interest in the July series of options—which assumed front-month status after the closing bell last Friday (June 17)—with close to 1,700 contracts in residence.

In similar fashion, the now in-the-money July 72.50 put saw almost 800 contracts change hands— 81% of which crossed at the ask price, hinting at buyer-driven volume. Plus, put open interest at the strike jumped by almost 700 contracts overnight, again pointing to the initiation of fresh positions.

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However, as you'll notice in the chart above, the July 85 strike was also quite popular on both sides of the options aisle. Upon closer inspection, it looks like one options trader constructed a bearishly skewed long straddle by simultaneously purchasing equal amounts of calls and puts on the strike.

Specifically, the investor bought several hundred July 85 puts for the ask price of $16.10 apiece. Meanwhile, to hedge against a significant short-term rebound, the trader also bought several hundred July 85 calls for the ask price of $1.40 apiece. Or, simply put, the speculator constructed the straddle for a net debit of $17.50 per pair of options, which represents his maximum risk on the play.

NEXT: Two Ways to Profit on This Straddle Trade

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As alluded to earlier, the straddle has a pessimistic slant since the investor paid significantly more for the put than the call (as the put is deep in the money). This bias can also be seen in the breakeven rails on the play, as the trader needs the shares of LNKD to make one of two moves within the options' lifetime: Either rally north of the $102.50 level (strike plus net debit), marking a 50% jump from the stock's close of $68.27 on Thursday; or fall beneath the $67.50 level (strike minus net debit), which would necessitate a drop of just 1.1%.

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Technically speaking, the shares of LNKD have blazed a steady path lower since their debut on May 19.

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In fact, the security is down almost 20% from its IPO price of $83 and sits roughly 50% south of its post-IPO high of $122.69. Now, the equity will likely be in a battle with its newly formed ten-day moving average, which is currently lingering in the $73.50 region.

Should this short-term trend line continue to pressure the shares into uncharted territory, the aforementioned straddle strategist's profits will accumulate as the 85-strike puts move deeper into the money.

By Andrea Kramer, contributor, Schaeffer’s Trading Floor Blog

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