Consolidation is brewing in the financial sector, as NYSE Euronext (NYX) is in advanced merger discussions with Deutsche Boerse. If this pairing comes to fruition, it would create the world's largest financial exchange, with trading capabilities on both sides of the Atlantic.
This potential pairing has reignited takeover talk in CBOE Holdings (NASDAQ:CBOE), which is the leading options exchange in terms of volume. The exchange just held its IPO last year – raising almost $340 million in the process – but some analysts are suspecting it could already be looking toward its next big change.
Thursday morning, CBOE reported fourth-quarter earnings of 32 cents per share, three cents above analysts' estimates. Revenue was slightly above the consensus view as well. Exchange officials referenced the M&A talk but neglected to comment specifically, merely noting its own competitive position.
Amid the merger speculation and the options volume, options volume has spiked. Almost 20,000 option contracts traded in CBOE on Wednesday, compared to January's average daily option volume of 1,500 contracts. Obviously some of this attention has been on the bullish side and some on the bearish side. (Specifically, 14,500 calls traded versus 5,200 puts).
For both sides of the CBOE debate, we've outlined two option strategies below. These examples are for educational and demonstrative purposes only and are not buy/sell/hold recommendations.
All prices below are from Thursday morning, when CBOE was trading at $25.45, down six cents in early trading.
Bullish Option Strategy: Synthetic Long Stock (Split-Strike)
Traders who are bullish on increased option volume could consider a synthetic long stock position, which uses a long call and short put to simulate the returns of a long stock with a lower capital requirement at the outset of the trade. With CBOE trading at $25.45, an investor could buy a March 26 call for 95 cents and sell the March 24 put for 55 cents, paying a net debit of 40 cents per spread.
At the outset, this strategy has a delta of almost 75, meaning the position will gain 75 cents for every one-dollar advance in the stock (and will lose 75 cents for every dollar CBOE shares decline). At expiration, gains are unlimited above the breakeven price of $26.40 (the call strike plus the overall premium paid). Losses are unlimited down to zero because of the naked short put.
Between the strike prices of 24 and 26, the position loses 40 cents at expiration. This is visible in the profit/loss chart below. OptionsHouse customers, including those using virtual trading accounts, have access to the profit/loss calculator and other tools. This calculator illustrates how the profit/loss relationship shifts due to movements in the stock price, implied volatility, or other factors.
Bearish Option Strategy: Ratio Put Spread
Those who are bearish on CBOE and believe the stock is ready for a pullback could consider a ratio put spread, which has limited downside exposure down to a point. Traders could buy one March 25 put and simultaneously sell two March 23 puts, paying a net debit of 40 cents.
When the options expire, profit is maximized if CBOE is trading right at the short strike (23). The maximum profit is $1.60, or the difference between strike prices less the debit paid. The breakeven prices for this strategy are $24.60 to the upside (the long strike less the premium) and $21.40 to the downside, or the short strike less the maximum potential profit. This offers a downside hedge of about 16% from its current price down to the lower breakeven.
To the upside, should CBOE rally, losses are capped at the 40-cent premium paid anywhere above the 25 strike. Downside risk is more significant due to the one uncovered short put that is in-the-money below 23. The second short put is effectively cancelled out by the long put. If CBOE were to decline and take out the lower breakeven level, losses are on par with a long stock position.
Please refer to Characteristics and Risks of Standardized Options, copies of which can also be obtained by contacting our Customer Service Department at customerservice@optionshouse.com.