Follow This Massive Downside Trade With A Potential 1,100% Return

| February 7, 2018 | 0 Comments

optionsOne of the most interesting aspects of options trading is that you never quite know what traders are thinking when they make trades.  It’s difficult to be 100% sure of their goals when they initiate a certain position.

Part of the mystery is due to how flexible an investment options can be.  Perhaps more importantly, options are often paired with stocks (or futures) to create an entirely different type of strategy (than with options alone).

For instance, you may be researching options trades and come across a short call trade.  On its own, a short call is a bearish or neutral trade on the underlying instrument.  However, if that short call is paired with long stock, it becomes a covered call, which is a moderately bullish trade.

Another common example of this scenario is with long puts.  A naked long put is a bearish strategy.  However, pair that long put with long stock and it becomes a hedge, or downside protection.  In that case, the put buyer would prefer the stock to go up and is just placing the long put to lower risk (or preserve capital).

So you can see, it’s generally not obvious what the goal of a particular options trade is.  We can do our best to take an educated guess on what it means – but there could be more going on behind the scenes that we’ll never know.  That’s one reason why it can be very beneficial to have a coach or mentor who has lots of experience studying the options market.

Here’s the thing…

A huge trade hit the wire this past week, and it’s one of those trades where the goal of the strategy is quite uncertain.

StarbucksThe trade I’m referring to is a January 2019 put spread in Starbucks (NASDAQ: SBUX) where the trader bought the 40 puts and sold the 35 puts for the cost of $0.37 (with the stock at $56).  This put spread was executed a whopping 92,300 times, which puts the premium cost (max loss) at $3.4 million.

And since I’m sure you’re curious, the max gain is at $35 or below by next January.  In that case, the position would be worth $4.63 or $42.7 million (a potential return of over 1,100%).  We’re obviously talking about a trader (probably a firm) with a lot of capital to throw around.

So the question is, is this put spread a huge bearish bet on SBUX, or is it a hedge against a very large amount of long stock?

In this case, it’s a very interesting question because I don’t think the answer is obvious.  Typically, when large amounts of put spreads are purchased like this, they are being used to hedge a long position.  You see this sort of trade in index ETFs all the time.

On the other hand, I personally would expect a hedge to be closer to the stock price of $56.  Something like the 45-50 put spread seems to me like a more likely hedge.  Now, that’s not to say this isn’t a hedge.  Someone with complex risk modeling software may have determined that 35-40 is where they need to be hedged if they are long a large amount of SBUX shares.

Still, given how far the put spread is from the stock price, how cheap it is, and how long we have until expiration, I would not be shocked if this was bearish bet on SBUX.  The company has been struggling lately, as you can see from the chart.

If you’re long SBUX shares and you want to hedge, I’d recommend higher strikes.  If you’re betting on a bearish move and want to buy about a year’s worth of time on the strategy, this trade is not a bad way to do so.


Pay Your Bills for LIFE with These Dividend Stocks

Get your hands on my most comprehensive, step-by-step dividend plan yet. In just a few minutes, you will have a 36-month road map that could generate $4,804 (or more!) per month for life. It’s the perfect supplement to Social Security and works even if the stock market tanks. Over 6,000 retirement investors have already followed the recommendations I’ve laid out.

Click here for complete details to start your plan today.


Tags: , , , , , , , , , , ,

Category: Options Trading Strategy

About the Author ()

Jay Soloff is an options analyst with Investors Alley.