Options Trade of the Day: A Synthetic Long on VIVUS Inc.


VIVUS Inc. ( VVUS ) found itself squarely in the headlines last week, after the company scored an upgrade to "overweight" from "neutral" at JPMorgan . According to the brokerage firm, although VVUS received a rejection letter from the Food and Drug Administration (FDA) for its obesity drug, Qnexa, the letter "provides a manageable path to approval in 2011, which should be enough to drive meaningful appreciation in VVUS shares over the next several quarters."

Following the news, VVUS puts have been quite popular, with volume more than tripling the stock's daily average so far today. However, not all of this activity has been bearish in nature, as one trader combined puts and calls to create a considerably bullish position on VVUS.

Specifically, 500 November 7 puts traded at 10:02 a.m. on the Chicago Board Options Exchange ( CBOE ) for the bid price of $0.45, or $45 per contract. This block was marked "spread." After a bit of digging, I found the other half of this trade on the November 7 call, where 500 contracts traded at the same time on the NYSE for the ask price of $0.65, or $65 per contract. Given this data, it would appear that we are looking at a synthetic long position on VIVUS Inc.

VVUS November 7 put and call volume details

The Anatomy of a VIVUS Inc. Synthetic Long Position

Before we get into the particulars, a synthetic long options trade attempts to replicate as closely as possible a long stock position. The trader typically buys at-the-money calls and sells at-the-money puts in equal numbers, all with the same expiration date. By using options, the trader gains considerable leverage, allowing for greater returns on the position than those achieved by investing the same amount of money in a stock position.

Overall, the trader paid $0.65, or $65 per contract, for each November 7 call, and received a credit of $0.45, or $45 per contract, for each November 7 put sold. As such, the total cost of this VVUS synthetic long position comes in at $0.20, or $20 per pair of contracts. For those curious readers out there, the total outlay at initiation would have been $10,000.

VVUS synthetic long details

The maximum profit on this trade is theoretically unlimited, since there is no cap to how high VVUS shares can rally. The maximum loss, while considerable, is limited to the strike price of the sold November 7 put plus the debit paid, or $7.20 -- $720 per contract. Breakeven, meanwhile, is also calculated by adding the total initial debit to the strike price of the purchased November 7 call, and arrives at $7.20. Below is a chart for a rough visual representation of the trade's profit/loss scenario:

VVUS synthetic long profit/loss chart

Implied Volatility

Rising implied volatility is pretty neutral for a synthetic long trade. First, it lifts the value of both the purchased and the sold options, thus increasing the cost to buy back the sold put and boosting the premium received when selling the purchased call. At the time the position was entered, implied volatility for the VVUS November 7 call was 82.44%, while implieds for the November 7 put were 84.90%. For comparison, VVUS's one-month historical volatility arrived at 95.56% as of the close of trading on Friday.

Synthetic Long Versus Stock Ownership

For a bit of perspective on why a trader would opt for a synthetic long position over purchasing the stock outright, let's run a quick comparison. For this example, assume that Trader Bob bought 100 shares of VVUS for $7 each, for a total of $700 (excluding charges and broker fees). Meanwhile, Trader Joe buys one November 7 call and sells one November 7 put for a total debit of $0.20, or $20 per pair of contracts (again, excluding charges and broker fees). Both traders control 100 shares of VVUS, but Trader Bob spent $700, while Trader Joe paid only $20.

Let's say that VVUS closes at $9 per share on November expiration. If Trader Bob closes out his entire position, he would earn $2 per share, resulting in a profit of $200. For Trader Joe, the November 7 put would expire worthless, while the November 7 call would be worth $2. As a result, Trader Joe would earn $2 minus his initial debit of $0.20, bringing his profit on the entire position to $1.80, or $180 per contract. Now, imagine if Trader Joe had risked the same amount of capital as Trader Bob, and you can see why synthetic long option trades can be quite lucrative for bullish traders.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

All Rights Reserved. Unauthorized reproduction of any SIR publication is strictly prohibited.

This article appears in: Investing , Options

Referenced Stocks: CBOE , VVUS

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