With the stock fresh off a series of all-time highs, speculation
is beginning to heat up on India-based Tata Motors Ltd. (
). The stock's long-term uptrend accelerated in November, with
traders snatching up the shares in the wake of a
stronger-than-expected second-quarter earnings report on Nov. 9.
Technically, TTM has bested the S&P 500 Index (SPX) by more
than 44% during the prior 60 trading days, extending its
year-to-date advance to more than 100%.
As you might expect, the stock's impressive run has attracted
its fair share of skeptics. On the options front, TTM's Schaeffer's
put/call open interest ratio (SOIR) of 1.28 ranks above 91% of all
those taken during the past year. In other words, options traders
have been more pessimistically aligned only 9% of the time in the
prior 52 weeks.
Calls are the option of choice today, with nearly 3,000 of these
typically bullish bets changing hands so far this afternoon, more
than tripling TTM's average daily call volume. However, a closer
look at this volume reveals another dose of skepticism, as most of
these calls are trading at the bid price, suggesting selling
activity. Nestled amid this flood of calls, one trader entered what
appears to be a short straddle on Tata Motors.
The Anatomy of a Tata Motors Short Straddle
To construct the TTM short straddle, the trader sold 100
December 35 calls at 9:52 a.m. Eastern time on the American Stock
Exchange (AMEX) for the bid price of $1.60, or $160 per contract.
At the same time, the trader also sold 100 December 35 puts for the
bid price of $2.30, or $230 per contract. The result is a net
credit of $3.90, or $390 per pair of contracts.
There are two ways the short straddle trader can bank a profit.
The most lucrative path to profit occurs if TTM closes at the sold
35 strike when December options expire. In this scenario, both the
sold 35 call and sold 35 put expire worthless, allowing the trader
to retain the entire premium of $390, or $39,000.
The second, and slightly more complicated, path to profit
involves decaying time value and/or a drop in implied volatility.
All options lose time value as they approach expiration, and, as
long as implied volatility remains steady, the December 35 call and
35 put will decline in value as expiration draws near.
Additionally, the price of these options will also fall should
their implied volatility decline. In this scenario, the trader's
profit is equal to the difference between the initial net credit
received and the price of the options when the position is closed
(i.e., the options are bought back).
As with all options strategies, there are risks involved.
However, those risks can be quite substantial for short straddle
traders. Theoretically, if the stock rallies, losses are unlimited,
as there is no limit to how high the shares can move before the
trader is forced to buy back the sold calls or purchase the stock
to fill the assigned call option. Meanwhile, losses on a downside
move are capped at the strike price minus the premium received. In
this case, the maximum loss on a plunge in TTM shares would be
$31.10 -- 35 - $3.90 = $31.10 -- or $3,110 per contract.
Finally, 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 $38.90
-- 35 + $3.90 = $38.90 -- and $31.10 -- 35 - $3.90 = $31.10. For a
rough visual representation of this Tata Motors short straddle, see
the chart below:
As noted above, implied volatility is another key factor to
consider when entering a short straddle position, as a decline in
implieds can be an alternate route to profit on the position. Since
the trader is selling the options, he is looking for inflated
premiums at the start of the trade in order to maximize the net
credit on the trade. At the time of the trade, implieds for the
December 35 call were 80.84%, while the implied volatility for the
December 35 put rested at 72.26%. For comparison, the stock's
one-month historical volatility arrived at 75.17% as of the close
of trading on Friday.
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