Sprint Nextel Corp. (
) is expected to report a second-quarter loss of 19 cents per share
on July 28. Earnings reports can spur large moves in a security if
a company matches or misses these expectations. Options traders are
betting on just such a development for S, as speculators are piling
into both puts and calls on this telecommunications concern.
Overall, call volume has swelled to more than 60,000 contracts
today, with traders sending some 57,000 of these calls across the
tape on S' August 5 strike. Meanwhile, put volume has spiked to
about 30,000 contracts, with 22,900 of these puts crossing on S'
August 4 strike.
Zeroing in on these most active strikes, I uncovered what
appears to be the initiation of a strangle position on S heading
into the company's earnings report. Specifically, a block of 2,500
S August 5 calls traded at 12:56 p.m. Eastern time on the New York
Stock Exchange (NYSE) for the ask price of $0.24. At the same time
on the same exchange, two blocks of August 4 puts, totaling 2,500
contracts, traded at the ask price of $0.03. By implementing this
strategy, the trader needs S to move sharply before these options
expire on Aug. 20; direction doesn't matter.
For those not familiar with this options strategy, a strangle is
the simultaneous purchase or sale of an equal number of puts and
calls on a given underlying stock with the same expiration date but
strike prices. The strangle purchaser is looking for a large move
by the stock; one that exceeds either strike level by more than the
amount of the premium paid for both options.
The Anatomy of a Sprint Nextel Corp. Strangle
Drilling down on today's S strangle, the trader purchased 2,500
August 5 calls for $60,000 -- ($0.24 * 100) * 2,500 = $60,000. At
the same time, the trader also purchased 2,500 August 4 puts for
$7,500 -- ($0.03 * 100) * 2,500 = $7,500. The total outlay for this
position would be $67,500 -- $60,000 + $7,500 = $67,500.
There are two ways of determining the maximum profit on a
strangle position. If S jumps higher, then the maximum profit is
theoretically unlimited, as there is no cap to how high the shares
can rally. If S plunges, the maximum profit is limited to the
purchased put strike minus the total debit paid. For this position,
the maximum profit from a downside move is $3.73, or $373 per
There are two breakeven points for this position. They are
calculated by adding the net debit paid to the purchased call, and
subtracting the net debit paid from the purchased put. For the
example, the breakevens are $5.27 -- 5 + 0.27 = $5.27 -- on the
upside, and $3.73 -- 4 - 0.27 = 3.73 -- on the downside. Finally,
the maximum loss is limited to the net debit paid upon entering the
position. Below is a chart for a rough visual representation:
Traders should not be afraid of rising implied volatility
following the initiation of a strangle position. An increase 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 S August 5
call were 47.94%, while the implied volatility for the August 4 put
rested at 60.62%. For comparison, the stock's one-month historical
volatility came in at 29.20% as of the close of trading on Friday,
meaning that both options are relatively expensive at the
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