Financial services firm Legg Mason Inc. (
LM
) has been far from exciting on either side of the bull/bear coin
in 2010, with the equity shedding about 3% on a year-to-date basis.
By comparison, the S&P 500 Index (
SPX
) has declined about 4% during the same time frame. Technically
speaking, LM has been trapped between support near $28 per share
(barring a spot of weakness around the beginning of the year), and
resistance near $34 per share.
Now, LM's price action may not seem very attractive from an
options-trading standpoint, but more informed traders know that
there are several ways in which to profit from a stagnating stock.
One of the more popular, and least complicated, methods of taking
advantage of a technical pattern similar to LM's is to sell option
premium by opening a put-sell position.
For example, buried within LM's wealth of put volume today is
what appears to be a put-sell position. Specifically, a block of
275,000 August 28 puts traded on the Philadelphia Stock Exchange (
PHLX
) at about 10:08 a.m. for the bid price of $1.20, or $120 per
contract. The sheer size of the trade leads me to believe that it
is institutional in nature, meaning that there could be more than
meets the eye to this particular example. But, for the purposes of
today's example, let's assume that this block is a straight up
put-sell position.
The Anatomy of a Legg Mason Put-Sell Position
So, after selling 275,000 August 28 puts for $1.20, the trader
will receive a credit of $120 per contract, or a whopping $33
million total -- (1.20 * 100) * 275,000 = $33 million. In order for
the trader to retain the entire premium received, LM needs to hold
above the $28 level through Aug. 20, when these options expire. The
maximum theoretical loss on this position is limited to the strike
price minus the premium should the stock go to zero, while the
maximum profit is capped at the initial premium received when the
options were sold. Below is a profit/loss graph for a visual
representation:
Implied Volatility
Rising implied volatility can be deadly to a put-sell trader, as
it lifts the value of the sold option, potentially increasing the
cost to buy back the contract if the underlying stock moves sharply
against you. Declining volatility, meanwhile, has the opposite
effect, making it less expensive to repurchase the option, should
the need arise. At the time of the trade, implieds for the LM
August 28 put were 41.94%. For comparison, LM's one-month implieds
rested at 41.7% as of the close of trading on Thursday.
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