Options Trade of the Day: Betting on a Rebound for American Express Co.

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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.

AXP October 39 put and call volume details

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.

AXP synthetic long details

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:

AXP 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 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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This article appears in: Investing , Options

Referenced Stocks: AXP

Schaeffer's Investment Research

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