Options Trade of the Day: Limit Losses on a Bullish Intel Corp. Play Ahead of Earnings

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Intel Corp. ( INTC ) is expected to report a profit of 50 cents per share after the close of trading tomorrow. In the same quarter last year, the company posted a profit of 33 cents per share. Historically, Intel has bested the consensus estimate in each of the prior four reporting periods, with an average upside surprise of roughly 18%.

As you might expect, options activity is starting to pick up on this semiconductor specialist, especially on the call front. Some 113,000 of these bullishly oriented contracts have changed hands on INTC today. Overall, the out-of-the-money October 20 call has attracted the most attention, with about 23,000 contracts crossing the tape. The most popular put, meanwhile, is the October 19 strike, where some 12,000 puts have traded so far.

While most of INTC's options activity is taking place in the front-month October series, a more interesting trade on the semiconductor giant took place in the back-month November series. Specifically, a block of 5,000 INTC November 21 calls traded at 11:27 a.m. Eastern time on the Philadelphia Stock Exchange (PHLX) for the bid price of $0.19. The second half of this spread took place on INTC's November 20 call, where 5,000 contracts traded at the same time on the same exchange for the ask price of $0.51. Given this data, it would appear that we are looking at a vertical call spread, more commonly known as a debit spread , on Intel Corp. This options strategy is also known as a long call spread, or a bull call spread.

INTC November 20 and 21 call volume details

The Anatomy of an Intel Corp. Vertical Call Spread

Breaking down this potential debit spread position, the trader purchased 5,000 November 20 calls for the ask price of $0.51, resulting in a debit of $255,000 -- (0.51 * 100) * 5,000 = $255,000. In the absence of the premium received by selling the November 21 call, the trader would need INTC to rally roughly 5%, from Friday's close at $19.52, to $20.51 per share, in order for the position to reach breakeven at expiration. Furthermore, the maximum loss on this leg of the position is limited to the initial investment of $255,000.

As you can see, the second leg of the debit spread helps to offset the cost of the overall position. In this case, the trader sold 5,000 November 21 calls for the bid price of $0.19, netting a total credit of $95,000 -- (0.19 * 100) * 5,000 = $95,000. Combining this leg of the trade with the purchased November 20 call lowers the total cost of the entire position to $160,000 -- $255,000 - $95,000 = $160,000.

The addition of the sold November 21 call also lowers breakeven on the trade. To arrive at breakeven, we subtract the credit received from the sold November 21 call from the debit incurred by purchasing the November 20 call. We arrive at a cost of $0.32, or $32 per pair of contracts. As a result, the trader now needs INTC to rally roughly 4%, to $20.32, in order to recoup the initial investment on the entire position.

INTC vertical call spread details

The maximum profit is calculated by subtracting the net premium paid from the difference between the two strikes, and is reached if INTC rallies to $21 per share at expiration. In this case, the maximum profit is $0.68 -- (21 - 20) - 0.32 = $0.68 -- or $68 per pair of contracts. The maximum loss is equal to the net debit of $0.32, or $32 per pair of contracts. Below is a chart for a rough visual representation of the trade's profit/loss scenario:

INTC vertical call spread profit/loss chart

Implied Volatility

After the vertical call spread has been entered, increasing implied volatility is pretty much neutral to the overall position, as it lifts the value of both the sold option and the purchased option. At the time of the trade, implieds for the November 20 call were 27.42%, while the implied volatility for the November 21 call rested at 26.02%. For comparison, INTC's one-month historical volatility was perched at 20.18%.

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This article appears in: Investing , Options

Referenced Stocks: INTC

Schaeffer's Investment Research

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