The February options series opened for business in Wells Fargo (NYSE:WFC) yesterday and one large-scale options investor appears to have swooped in to extend a bearish trade. Wells shares are up 9.5% in the past month and have gained slightly more than that year-to-date, but this investor evidently expect the banking giant to experience some moderate downside during the next couple of months.
In mid-session trading on Monday, large blocks traded on the January 27.50 put and the February 25 and 28 puts. Looking at volume, open interest, and pricing trends, it appears as though the January puts were sold to close while a bear put spread was opened in the February series. All of the volume changed hands right around the same time and all of the activity was marked as spread trading.
In other words, investors sold to close existing long puts in the January series and opted to roll out this bearish thesis in a more conservative way, buying the February 28 puts and selling the 25 puts. A bear put spread requires less capital outlay than a standard long put but will also cap gains as well as limit losses.
The 20,000 lot of this bear put spread traded for a net debit of 48 cents (or $960,000 in total), with the February 25 puts sold for 20 cents each and the February 28 puts purchased for 68 cents each. This premium paid is also the most the spread trader can lose, if WFC is trading at 28 or above when the options expire.
Breakeven for this spread is $27.52, or the long put strike less the debit paid. This is roughly 8.5% lower than the stock's current price of $30.10, so the investor is hoping for a fair amount of downside through February expiration in about 60 days. If WFC does decline dramatically, profits are capped at $2.52, which is the difference in strike prices less the debit paid. At expiration, profits peak below the 25 strike. Return on risk for this spread is 525%, or the maximum potential gain of $2.52 divided by the maximum potential loss of $0.48.
Today, delta for this out-of-the-money put spread is -16.6. For any dollar decline in WFC shares, the spread will theoretically gain 16.6 cents. Conversely, the spread will lose 16.6 cents for every dollar the stock declines. Assuming no movement in the stock or in underlying volatility, delta will decrease as the time until expiration evaporates.
WFC recently edged back above the 30 level after several months below this round-number threshold. Perhaps Monday's option action shows an expectation for the stock to face resistance from this strike over the near term.
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