Options Trade of the Day: Devon Energy Trader Bets on a Sharp Post-Earnings Move


Options traders are jostling for position ahead of Devon Energy Corp.'s ( DVN ) trip to the earnings confessional on Aug. 4. The oil and natural gas exploration firm is expected to post a profit of $1.42 per share ahead of the open on Wednesday, compared to last year's profit of just 85 cents per share. Historically, DVN has been a solid fundamental performer, besting the consensus estimate in each of the prior four reporting periods by an average of 31%.

Technically, a little volatility would be a welcome change for DVN investors, as the stock has remained trapped between support near $60 per share and resistance in the $70 region since March. Currently, the stock is being squeezed into the lower rail of this trading range by resistance at its 10-week and 20-week moving averages.

Weekly chart of DVN since January 2010 with 10-week and 20-week moving averages

At least one options trader is betting that the stock's days of tranquilly drifting sideways are numbered. At about 11:24 a.m. Eastern time, a block of 1,500 October 65 calls traded on the Philadelphia Stock Exchange (PHLX) for the ask price of $3.00, or $300 per contract. At the same time, a block of 1,500 October 65 puts changed hands for the ask price of $3.70, or $370 per contract. Given this data, it appears that we are looking at a long straddle on Devon Energy Corp.

DVN call and put volume

For those not familiar with this options strategy, a straddle is the simultaneous purchase or sale of an equal number of puts and calls on a given underlying stock with the same expiration date and the same strike price. The straddle purchaser is looking for a large move by the stock, one that exceeds the strike by more than the amount of the premium paid for both options.

Devon Energy Corp. Straddle Details

Breaking down this trade, the trader paid $450,000 for the block of 1,500 October 65 calls, while shelling out $555,000 for the 1,500 October 65 puts. As such, the total debit for entering this DVN strangle arrives at roughly $1 million. To recoup the cost to enter this trade, the trader needs the stock to either rally to $71.70 per share or plunge to $58.30 per share. With DVN currently trading at $64.46 per share, this means that the stock needs to either jump 11.3% or fall about 9.5% for the position to reach breakeven.

DVN strangle breakdown

The maximum profit is unlimited to the upside, and limited to $58.30, or $5,830 per contract, on the downside. Below is a visual representation of the trade's profit/loss potential:

DVN straddle profit/loss chart

Implied Volatility

Traders should not be afraid of rising implied volatility following the initiation of a straddle position. A rise in implieds increases the value of the purchased options, allowing the trader to collect a higher return by selling (to close) the position. At the time of the trade, implieds for the DVN October 65 call were 28.57%, while the implied volatility for the October 65 put rested at 28.93%. For comparison, the stock's three-month historical volatility came in at 35.54% as of the close of trading on Friday.

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This article appears in: Investing , Options

Referenced Stocks: DVN

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