Many ways to profit in ITT trade


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An investor bought a calendar spread on ITT Educational Services yesterday, creating several ways to profit from the heavily shorted college stock.

A block of 4,948 June 70 puts was purchased for $3.90 and an equal number of May 70 puts were sold for $2.40, resulting in a net cost of $1.50. Volume was above open interest in both strikes, confirming it was a new trade.

The position essentially makes the investor long volatility in the stock because the June puts have a higher vega than the May puts, meaning they will increase in value more quickly if option premiums increase overall in the name. (See our Education section)

Another benefit is that the May contracts will lose value more quickly because they are closer to expiration. For the trade benefit from these mechanisms, however, ESI must remain above $70 through May 20. It was at $71.62 when the transaction appeared.

Afterwards, it continued falling and ended the session down 5.19 percent to $69.62, which presents the investor with an interesting situation. If ESI remains at this level or goes lower, he or she will be obligated to buy shares for $70 on or before May expiration.

While this is not normally the intention when a calendar spread is implemented, it offers another potential route to profit. In this case, the investor would be long shares for $70, while also owning the June puts as protection for less than half of their normal price.

This comes as ESI is potentially ready to turn higher. Last year, the education sector got crushed as investors worried about falling enrollment and tighter student-lending standards. But unlike other industries at moments of distress, these companies have no bankruptcy risk because they carry no debt. At a certain point it's hard for them to continue falling.

Short interest was also a hefty 50 percent of ESI's float in mid-April, so if no one is left to sell the stock, it could get squeezed higher. Additionally, the company reported better-than-expected results on April 21, which could add further fuel to the upside. It popped on that news and has held most of the gain since then.

Overall option volume in ESI was 7 times greater than average yesterday, with puts accounting for 87 percent of the total.

(Chart courtesy of tradeMONSTER)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

This article appears in: Investing Options
Referenced Stocks: ESI

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