Options Trade of the Day: A Put-Sell Position on Legg Mason Inc.

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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.

Daily chart of Lennar since October with 10-day and 20-day moving averages

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.

LM options activity

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:

LM options activity

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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This article appears in: Investing , Options

Referenced Stocks: LM , PHLX , SPX

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