|Back to main|
Dissecting a Bear Call Spread on General Electric Company
3/15/2011 1:45:00 PM
By: Schaeffer's Investment Research
Shares of General Electric Company ( GE ) have taken a 4.3% hit this week, as the Dow component suffers steep losses amid the ongoing nuclear crisis in Japan. As a result, GE's seven-week reign above the round-number $20 region has been unceremoniously snapped -- and one opportunistic options trader is betting this area will now act as a stubborn technical ceiling.
Specifically, the speculator sold a block of 5,000 June 20 calls, and simultaneously purchased an equivalent number of June 22.50 calls, for a net credit of $0.63 per pair of contracts. Implied volatility rose on both options following the trades. Assuming both blocks are freshly opened, this appears to be a bear call spread , or short call spread, on GE.
The ultimate goal of this neutral-to-bearish strategy is for the underlying equity to finish at or below the sold strike upon options expiration. In this case, the trader is expecting GE to remain pinned beneath $20 through the close of trading on June 17, when these options are set to expire. This will allow both options to expire worthless, requiring no further action on the trader's part to unwind the play.
Meanwhile, the purchased call is utilized only to limit the trader's risk. Even if GE should unexpectedly skyrocket to $30 during the next couple of months, the most the trader can possibly lose is limited to the difference between the two strike prices, less the initial net credit. In this case, the maximum risk is $1.87. On the other hand, the profit potential is capped at the net credit of $0.63.
Checking out the charts, GE is down about 3% at last look. The round-number $20 neighborhood previously acted as resistance during November 2008 and April 2010, and today's spread speculator is no doubt hoping that GE continues to be stifled by this psychologically significant area.