Exxon Mobile (XOM) is off $2.47 to $82.50 after crude lost more than $2.50 and fell to less than $79 per barrel Thursday. Crude is now at its lowest levels since early-October and has plummeted nearly 30 percent since late-April. One player in the options market made a well-timed bet in anticipation of weakness in XOM this morning. It’s a plain vanilla put spread that’s a 65 percent winner in just a couple of hours. Let’s take a closer look at the strategy:
In morning trading Thursday, a July 80 – 85 put spread was apparently bought on the stock this morning for $1.30, 10000X on PHLX. In this position, 10,000 July 85 puts was bought for $1.68 and 10,000 July 80 puts sold for 38 cents, and a $1.30 net debit was paid. Shares were trading for $84.55 at the time and the spread seems to be targeting a move to $80 or less through the expiration, or a 5.4 percent drop over the next 29 days. The breakeven at expiration is equal to the higher strike minus the debit, or $83.70, which represents a decline of 1.3 percent. The entire debit is at risk if shares hold above $85 and the position is left open through the expiration.
A vertical put spread is a popular strategy for making a bearish bet on the stock or to hedge a position. It is similar to buying puts, but selling a lower strike put helps mitigate some of the risk from time decay. The profits are limited by the downside puts as well. The max profit happens if shares fall below the lower strike. At that point, the payoff is equal to the spread minus the debit because you will be put the stock for $80 (assigned on the 80s), but you can sell (put) it to someone else at $85 per share. However, the position can be closed out at any time prior to the expiration. XOM fell to $82.50 and the XOM July 80 – 85 put spread can be sold at $2.15, for a 65 percent (or $850K) gain on this mornings trade.
Bear Put Spread
Strategy: Buy at-the-money or out-of-the-money put, Sell a Lower Strike Put (Buy July 85, Sell July 80)
Max Risk: Debit (1.30)
Breakeven: Higher Strike, Minus Debit (85 – 1.4 = 83.7)
Max Profit: Spread minus Debit (5 – 1.3 = 3.70)
About the Author (Author Profile)
Frederic Ruffy is a well-known trader, writer, and strategist who has spent years educating investors and creating intelligent, insightful, unbiased market observations that are frequently cited by the Wall Street Journal and other financial publications. As senior analyst, Fred provides frequent and regular notes and daily updates for activity of interest.