Option Collar: Safe Hedge with Low Cost

05/02/2012 7:00 am EST

Focus: OPTIONS

News reports about a scandal at Wal-Mart Stores (WMT) may have caused one options trader to hedge a long position by way of this low-priced collar, explains Karee Venema of Schaeffer’s Reserch.

Options players have preferred calls over puts on Wal-Mart Stores, Inc. (WMT) recently, as data from the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) suggests. Over the course of the past five trading sessions, traders on these exchanges have bought to open 18,685 calls compared to 13,048 puts. This brings WMT’s five-day call/put volume ratio to 1.43.

It appears, however, that this taste for WMT calls has been building in recent months, with the stock’s 50-day ISE/CBOE/NASDAQ OMX PHLX (PHLX) call/put volume ratio checking in at 2.12. This ratio ranks higher than 75% of other such annual readings, indicating that bullish bets have been picked up over bearish at accelerated levels in the past ten weeks.

What’s more, WMT’s Schaeffer’s put/call open interest ratio (SOIR) of 0.81 shows that call open interest outweighs put open interest among options set to expire within the next three months. This ratio ranks in the 45th percentile of its annual range, implying that short-term speculators are slightly more call-heavy than usual toward the stock.

During the course of a recent session, however, speculators were not discriminating, with 9,681 calls and approximately 10,000 puts crossing the tape. It appears that one shareholder used both calls and puts to employ a collar in the September-dated series of options.

One block of 3,000 September 62.50 calls changed hands at the bid price of $0.92, while a symmetrical block of September 55 puts traded near the ask price at $1.29. A net debit of $0.37 was incurred for the play.

While he’s obtained a cheap option hedge against any substantial pullbacks by WMT over the next five months, the shareholder is potentially limiting any upside gains should the stock rally north of $62.50, which would place the sold calls in the money.

On a technical basis, WMT has been all over the charts. On a year-over-year basis, the stock has tacked on 7.4%, but is down a slight 1.2% in 2012. Since January, the equity has largely been confined to the $58.50-$62.50 range. In fact, WMT has not experienced a daily close above $62.50 since early-September 2008.

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However, WMT did briefly break out of this range to the downside last week when news hit the Street that the Dow component is under investigation by the attorney general of Mexico for allegations of bribery. This news, and the stock’s ensuing plunge, may have inspired an urge to hedge among cautious investors.

By Karee Venema, contributor, Schaeffer’s Research

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