Walgreen (WAG) Will Get Well in Time

08/03/2011 8:00 am EST

Focus: OPTIONS

Andrea Kramer

Associate Editor, Schaeffer's Investment Research, Inc.

A major option player has just used long-term (LEAP) options to bet bullishly on Walgreen Co. (WAG), cleverly using a spread strategy in order to “get paid” to open this position.

Shares of drugstore diva Walgreen Company (WAG) have had a rough summer thanks to some merger-and-acquisition (M&A) news in the pharmacy sector. Specifically, Express Scripts (ESRX) announced plans to buy Medco Health Solutions (MHS), which will ultimately reduce the pool of potential pharmacy benefits manager (PBM) partners for company stores.

Nevertheless, it appears one option trader is keeping the faith and is simulating stock ownership by employing long-term options.

Last week, symmetrical blocks of January 2012 43-strike calls and January 2012 38-strike puts crossed the tape—both marked "spread." The blocks exceeded open interest at both the LEAP strikes, pointing to the initiation of new positions.

See related: Key Advantages of LEAP Options

However, while the calls traded at the ask price of $1.80 apiece, suggesting they were bought, the puts changed hands at the bid price of $1.90 each, hinting at seller-driven volume. Or, simply put, it looks like the speculator constructed a split-strike version of a synthetic long stock position.

In a nutshell, the trader bought the 43-strike calls to bet bullishly on WAG, but funded the position— and then some—by selling more expensive 38-strike puts, resulting in a net credit of ten cents per pair of options.

Like a stock owner, the strategist's profits will accumulate with each step north of $43 within the options' lifetime, as the puts will expire worthless and the calls will move into the money. However, the options trader actually got paid to open the position, instead of forking out a lot of cash to buy the shares outright.

Plus, the options trader is protected down to the $38 level (which WAG is nearing). In other words, he or she can still retain the ten-cent credit as long as WAG remains north of the put strike. The WAG shareholder, on the other hand, would lose money on a downside move.

chart
Click to Enlarge

Unlike this option trader’s strategy, though, most options traders are upping the bearish ante on WAG. During the past ten sessions, options players on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) have bought to open almost three WAG puts for every call. In fact, the security's ten-day put/call volume ratio of 2.98 stands just two percentage points shy of an annual pessimistic peak.

As a result of the growing affinity for puts, the equity's Schaeffer's put/call open interest ratio (SOIR) has ascended to 1.04, indicating that puts now outnumber calls among options slated to expire within three months. Furthermore, this ratio registers in the 69th annual percentile, confirming that near-term options traders are more put-heavy than usual on WAG.

However, these puts could actually work to WAG's advantage over the short term. Specifically, the August 40 strike is home to peak put open interest in the front-month series, with roughly 8,000 contracts in residence. This abundance of bearish bets could further reinforce potential round-number support for WAG in the near term.

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

Related Articles on OPTIONS