Shares of American Express Co. (
AXP
) plunged more than 6% on Monday, after the company announced that
it would not settle a lawsuit with the Department of Justice. As
Elizabeth Harrow reported yesterday, AXP saw a
wealth of put volume on the session
. By the close, more than 46,000 puts had changed hands, totaling
roughly 6.3 times the stock's daily average.
However, AXP calls were also quite popular on Monday, with
volume spiking to more than four times the norm. What's more, one
trader combined both puts and calls to create a considerably
bullish position on AXP, designed to take advantage of a potential
rebound in the stock. Specifically, 1,600 October 39 puts traded at
2:07 p.m. on the New York Stock Exchange (NYSE) for the bid price
of $0.68, or $68 per contract. This block was marked "spread."
After a bit of digging, I found the other half of this trade on the
October 39 call, where 1,600 contracts traded at the same time on
the NYSE for the ask price of $1.62, or $162 per contract. Given
this data, it would appear that we are looking at a synthetic long
position on American Express Co.
The Anatomy of an American Express Co. 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 at the same strike 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 $1.62, or $162 per contract, for each
October 39 call, and received a credit of $0.68, or $68 per
contract, for each October 39 put sold. As such, the total cost of
this AXP synthetic long position comes in at $0.94, or $94 per pair
of contracts. For those curious readers out there, the total outlay
at initiation would have been $150,400.
The maximum profit on this trade is theoretically unlimited,
since there is no cap to how high AXP shares can rally. The maximum
loss, while considerable, is limited to the strike price of the
sold October 39 put plus the debit paid, or $39.94 -- $3,994 per
contract. Breakeven, meanwhile, is also calculated by adding the
total initial debit to the strike price of the purchased October 39
call, and arrives at $39.94. Below is a chart for a rough visual
representation of the trade's profit/loss scenario:
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 AXP
October 39 call was 38.83%, while implieds for the October 39 put
were 37.89%. For comparison, AXP's one-month historical volatility
arrived at 29.79% as of the close of trading on Monday.
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 AXP for $39 each, for a total of $3,900
(excluding charges and broker fees). Meanwhile, Trader Joe buys one
October 39 call and sells one October 39 put for a total debit of
$0.94, or $94 per pair of contracts (again, excluding charges and
broker fees). Both traders control 100 shares of AXP, but Trader
Bob spent $3,900, while Trader Joe paid only $94.
Let's say that AXP closes at $41 per share on October
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 October 39 put would expire worthless, while the October 39
call would be worth $2. As a result, Trader Joe would earn $2 minus
his initial debit of $0.94, bringing his profit on the entire
position to $1.06, or $106 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.
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