VIVUS Inc. (
) 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 (
) 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.
The Anatomy of a VIVUS Inc. Synthetic Long
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.
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:
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
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