Put Spread Profits from DELL’s Pain

05/23/2012 7:00 am EST


Disappointing guidance has driven shares of Dell Inc. (DELL) sharply lower this month, and Karee Venema of Schaeffer’s Research dissects a long put spread intended to profit on continued weakness in the shares.

Options have emerged as the vehicle of choice on Dell Inc. (DELL) in recent sessions.

On one day last week alone, approximately 25,000 put contracts had crossed the tape by mid-day, representing five times the average intraday rate. Calls are trading at accelerated levels as well, with around 7,800 contracts changing hands, or two times the expected intraday volume.

One options player accounted for the bulk of these puts, which she used to employ a debit spread in the June-dated series of options. Specifically, one block of 10,000 June 15 puts crossed for $0.50, or above the ask price, while a symmetrical block of 10,000 June 14 puts traded at the bid price of $0.23. Volume outweighs open interest at both of these strikes, indicating new positions were being opened there. A net debit of $0.27 was incurred for the play.

By establishing the long put spread, the trader is expecting DELL to fall below $14 by June expiration, but not so far below that she regrets not buying the put outright.

In this scenario, the sold leg will expire worthless, and the speculator can pocket the maximum potential profit of $0.73 (the difference between the two strikes minus the net debit). However, she is still able to profit as long as DELL lands south of breakeven at $14.73 (bought strike - net debit). Should DELL fail to retreat beneath either of these levels by the closing bell on June 15, the maximum potential loss for the play is limited to $0.27.

On a technical basis, DELL hit the ground running in 2012, sprinting up the charts to a three-year high of $18.36 on Feb. 21. However, a weaker-than-expected first-quarter revenue outlook caused the shares to drop dramatically the day after hitting this price peak, and the stock has since been pressured lower by its 20-day moving average.

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See also: Great Example of a Bear Put Spread

By Karee Venema, contributor, Schaeffer’s Research

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