Shares of Ross Stores Inc. (
) are trading nearly 1% higher today, as the stock continues to
consolidate its recent gains into support in the $70-$70.50 region.
ROST was catapulted above this region due to buying momentum in the
better-than-expected fundamental data
released on Feb. 3. Despite the quick trip higher, ROST has stalled
after tagging a fresh all-time high of $71.93 on Feb. 14. What's
more, the recent drop in momentum has sparked a round of
speculation in the options pits, with traders turning toward put
Overall, more than 6,100 ROST puts have changed hands, with
options traders centering heavily on the March 70 strike. While
digging through ROST's put volume, I ran across a block of 2,000
contracts at the March 72.50 strike, which traded on the New York
Stock Exchange (NYSE) for the ask price of $2.95, or $295 per
contact. I found the other leg of this spread on the popular March
70 put, where 4,000 contracts traded for the bid price of $1.50, or
$150 per contract. Given this data, we could be looking at the
initiation of a vertical ratio put spread, or a
, on Ross Stores Inc.
The Anatomy of a Ross Stores Vertical Ratio Put
Breaking down this vertical ratio spread, the trader would have
purchased 2,000 March 72.50 puts for a total outlay of $590,000 --
(2.95 * 100) * 2,000 = $590,000. Meanwhile, the trader also sold
4,000 March 70 puts for a credit of $600,000 -- (6.43 * 100) *
4,000 = $600,000. Combining these two legs results in a net credit
of $10,000 -- $590,000 - $600,000 = $10,000.
The maximum profit on this vertical ratio put spread is achieved
when the underlying stock falls to the sold strike, which would be
the 70 level in this case. However, since twice as many March 70
puts were sold, this spread position will begin to lose money after
ROST moves below $70 per share. Once ROST breaches this region,
only half of the 4,000 sold March 70 puts are hedged by the 2,000
purchased March 72.50 puts. As such, the trader will begin to lose
money on the unhedged portion of those sold March 70 puts as ROST
moves lower. Below is a chart for a rough visual representation of
the trade's profit/loss scenario:
While a standard vertical put spread is not greatly impacted by
rising implied volatility, a spike in implieds could be detrimental
to a ratio spread. Since the trader has sold more contracts than he
has purchased, rising implied volatility on these options would
negatively impact the position, as it would make it more costly to
repurchase these contracts should the trader need to do so. At the
time of the trade, implieds for the March 70 put arrived at 24.76%,
while the implied volatility for the March 72.50 put rested at
26.68%. ROST's one-month historical volatility arrived at 25.40% as
of the close of trading on Tuesday.
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