Options Trade of the Day: A Weekly General Motors Co. Short Straddle Ahead of Earnings


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Ahead of the open on Thursday, Feb. 24, Detroit darling General Motors Co. ( GM ) is scheduled to release its fourth-quarter and fiscal 2010 earnings results. For the fourth quarter, Wall Street is expecting a profit of 47 cents per share, with full-year earnings seen arriving at $2.87 per share. Concerns have mounted heading into GM's quarterly report, especially after fellow automaker Ford Motor Co. ( F ) missed the consensus fourth-quarter estimate on Jan. 28.

In the options pits, call buying has been quite popular among traders on the International Securities Exchange (ISE), Chicago Board Options Exchange ( CBOE ), and NASDAQ OMX PHLX (PHLX) lately, as GM's collective 10-day call/put volume ratio arrives at 2.86. In other words, calls bought to open have nearly tripled puts purchased during the prior two weeks.

While call buying typically denotes bullish options activity, recent short selling activity could dampen this sentiment takeaway. Specifically, the number of GM shares sold short spiked by 32% during the past month. As such, some of this recent call-buying activity on GM may be the work of short sellers hedging their positions, and not options traders betting on a rally in the stock.

Turning back to today's options activity, volume is once again skewed toward the call side, with roughly 10,600 calls changing hands, versus more than 7,000 puts. Digging deeper into GM's options activity, I came across several blocks of puts and calls that changed hands at the bid prices. Additional research uncovered what appears to be a short straddle on GM using weekly options.

General Motors weekly options activity

The Anatomy of a Weekly General Motors Short Straddle

Short straddles have apparently gained in popularity recently, with retail concern Nordstrom Inc. ( JWN ) drawing a similar trade on Friday . While today's short straddle involves weekly options, its construction is the same as Friday's JWN straddle. Specifically, the trader sold 127 GM February 25 36-strike calls at 9:44 a.m. Eastern time on the ISE for the bid price of $0.68, or $68 per contract. At the same time, the trader also sold 127 February 25 36-strike puts for the bid price of $0.87, or $87 per contract. The result is a net credit of $1.55, or $155 per pair of contracts.

General Motors weekly short straddle breakdown

The position reaches its maximum profit if GM closes at $36 per share when these weekly options expire this Friday. In this best-case scenario, both the sold February 25 36-strike calls and puts would expire worthless, allowing the trader to retain the entire premium collected.

There are two breakeven points for this position. They are calculated by adding and subtracting the net credit received to/from the sold strike. For the example, the breakevens are $37.55 -- 36 + $1.55 = $37.55 -- and $34.45 -- 36 - $1.55 = $34.45.

Finally, the maximum loss on a downside move is limited to the strike price minus the net credit received, coming in at $34.45, or $3,445 per pair of contracts, and is reached if GM were to drop to zero at expiration. Meanwhile, the maximum loss on an upside move is theoretically unlimited, as there is no limit to how high GM can rally. Below is a chart for a rough visual representation:

General Motors short straddle profit/loss chart

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

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This article appears in: Investing Options
Referenced Stocks: CBOE , F , GM , JWN

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