A Bear Call Spread on a Penny Option

10/12/2011 7:00 am EST

Focus: OPTIONS

Andrea Kramer

Associate Editor, Schaeffer's Investment Research, Inc.

After a sharp recent rally, one trader is expecting chart resistance to force Trina Solar (TSL) lower and has executed a bear call spread in order to profit while still limiting risk if the rally continues.

Alternative energy issue Trina Solar Limited (TSL) has followed the broader equities market higher this week, tacking on more than 28% since tagging a new two-year low of $5.28 last week.

In fact, the stock is on pace to end right around its ten-day moving average for the third straight session—a feat not accomplished since late August. Nevertheless, it appears that one options speculator is betting on TSL to cower in the face of the $8 level, which is home to the equity’s descending 20-day trend line.

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Jumping right in, the investor on Thursday (Oct. 6) sold several hundred October 8 calls for the bid price of $1.01 apiece. While this in itself would be a straight-laced bearish play, the trader hedged their bets in the event of an extended rebound by simultaneously buying an equal amount of October 9 calls for 51 cents each.

In other words, the strategist implemented a bear call spread on TSL for a net credit of 50 cents per pair of options.

The goal of this position is for TSL to finish beneath the $8 level when October-dated options expire in a couple of weeks.

In the best-case scenario, all of the calls will expire without value, allowing the trader to retain the entire net credit. However, should TSL topple its 20-day trend line and rally north of the $9 level within the options’ lifetime, the addition of the bought 9-strike calls caps the investor’s risk at 50 cents per pair of calls (difference between strikes minus net credit).

Simply put, the strategist constructed a spread with a symmetrical risk/reward profile.

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From a sentiment standpoint, though, TSL is no stranger to bearish bets. On the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), the security sports a ten-day put/call volume ratio of 1.46, which is in the 77th annual percentile.

In other words, options players have bought to open TSL puts over calls at an accelerated clip during the past couple of weeks.

Further echoing that trend, the equity’s Schaeffer’s put/call open interest ratio (SOIR) of 1.73 indicates that puts nearly double calls among options with less than three months to expiration. What’s more, this ratio stands just five percentage points from an annual peak, suggesting near-term options traders have rarely been more put-heavy on TSL during the past year.

Elsewhere, short interest on the security skyrocketed 37.6% during the past month, and now represents more than one-third of the stock’s total available float. In fact, at TSL’s average daily trading volume, it would take about a week to repurchase all of these pessimistic positions.

However, not everyone on Wall Street has boarded the equity’s bearish bandwagon. According to Zacks, more than half of the 16 analysts following the stock maintain "buy" or better ratings, with not one "sell" suggestion in sight.

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Likewise, Thomson Reuters pegs the consensus 12-month price target at $17.05—more than double TSL’s current price.

From a contrarian perspective, the lingering optimism among the analyst crowd could leave TSL vulnerable to additional selling pressure. Should the stock give back its recent gains and continue its longer-term journey into new-low territory, a flood of downgrades and/or price-target cuts could exacerbate the equity’s challenges on the charts.

By Andrea Kramer of Schaeffer’s Research

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