Options Trade of the Day: A Short Ratio Put Spread for Salesforce.com Inc.


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Salesforce.com Inc. ( CRM ) has suffered this week, with the stock declining sharply in the wake of a bearish Barron's article titled "Shades of the Dot-Com Bubble." According to the article, the company's growth prospects are "not good enough to justify its sky-high share price." The negativity has sparked a wave of put volume in the options pits, with more than 7,800 of these typically bearish contracts changing hands today - more than triple CRM's average daily put volume.

Tucked away within today's heavy put activity is a rather interesting spread trade on the security. Specifically, 750 February 125 puts crossed at 11:37 a.m. on the NYSE for the ask price of $6.30, or $630 per contract. Meanwhile, the 500 February 135 puts changed hands at the same time on the NYSE for the bid price of $12.50, or $1,250 per contract. Given this data, it would appear that we are looking at a short ratio put spread, more commonly known as a credit spread , on Salesforce.com.

CRM option volume details

The Anatomy of a Salesforce.com Short Ratio Put Spread

Getting down to business, the trade breaks down like this: The trader paid $472,500 for 750 February 125 puts -- ($6.30 * 100) * 750 = $472,500. Meanwhile, the trader received a credit of $625,000 for selling 500 February 135 puts -- ($12.50 * 100) * 500 = $625,000. As a result, the trader has pocketed a total premium of $152,500 -- $625,000 - $472,500 = $152,500. The breakdown for this credit spread is listed below:

CRM short ratio put spread breakdown

There are several possible paths to profit for this position. The simplest route involves CRM closing above $135 per share on Feb. 18, when these options expire. In this situation, the trader need not lift a finger, as all of the options involved expire worthless, allowing him to retain the entire premium received upon entering the trade.

The second path involves the erosion of time premium or the decline of implied volatility, both of which would make the February 135 puts less expensive to repurchase. The trader has a slight edge in this situation, as implied volatility has been bid higher on CRM recently. At the time of the trades, implieds for the February 135 puts rested at 41.69%, while implied volatility came in at 45.77% for the February 125 puts. CRM's historical volatility came in at 36.63% as of yesterday's close, hinting that both options are expensive when compared to prior readings. Should implieds decline sharply enough, the trader could potentially buy back the contracts for less than the initial selling price, thus pocketing the difference.

The third outcome involves a sharp decline in CRM shares, which could occur if the selling pressure in the wake of the Barron's article gains momentum. The reason that the trader can profit from a sharp decline in the shares stems from the fact that he purchased 1.5 times as many February 125 puts as sold February 135 puts. As such, the position will begin to gain ground on the portion of those purchased February 125 puts not offset by the sold 135 puts as CRM moves lower. Below is a chart for a rough visual representation of the trade's profit/loss scenario:

CRM short ratio put spread profit/loss chart

The winter 2011 issue of SENTIMENT magazine is now available here.

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This article appears in: Investing Options
Referenced Stocks: CRM

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