Options traders are snatching up puts on discount PC manufacturer Dell Inc. ( DELL ) like they are going out of style today. In fact, more than 59,000 of these typically bearish bets have traded on the security so far, outstripping the stock's average daily near-term put volume of 4,471 contracts by a ratio of more than 13-to-one. What's more, today's attention to puts stands as a stark reversal from yesterday's preference for calls . The most active strike on the session is the March 13 put, where nearly 28,000 contracts have changed hands.
Speculators are mostly likely getting their final wagers in before the company releases its quarterly earnings report after the close today. Currently, analysts are expecting a profit of 37 cents per share, according to Thomson Reuters -- an improvement from DELL's profit of 9 cents per share during same quarter last year. Technically, DELL has been locked in a tight trading range between the $13 and $14.50 levels since November 2010. With the shares currently hovering closer to the top end of this range, options traders could be betting on a post-earnings reversal.
Drilling down on the activity at DELL's March 13 put, I discovered that the majority of today's volume has traded at the ask price. With volume easily outpacing open interest of just 9,624 contracts, much of this activity is likely of a buy-to-open nature. In fact, one block, totaling 25,000 contracts, accounts for nearly all of this volume. The block, which was marked "spread," traded on the NASDAQ OMX PHLX (PHLX) at 11:02 a.m. for the ask price of $0.24, or $24 per contract.
The second leg of this position was found on the March 12 put, as a block of 25,000 contracts traded at the same time on the same exchange for the bid price of $0.08, or $8 per contract. This block, too, was marked "spread." Given this data, we could be looking at the initiation of a vertical put spread, or a debit spread , on Dell.
The Anatomy of a Dell Inc. Vertical Put Spread
Breaking down this vertical spread position, the trader would have purchased 25,000 March 13 puts for a total outlay of $600,000 -- (0.24 * 100) * 25,000 = $600,000. Subtracting the sold leg of the debit spread, DELL would need to fall about 9.4%, from Monday's close at $14.09, to $12.76 per share, in order for the position to reach breakeven at expiration. Furthermore, the maximum loss on this position would be limited to the initial investment of $600,000.
However, the second leg of the debit spread helps to offset the cost of the overall position. Specifically, the trader sold 25,000 March 12 puts for a total credit of $200,000 -- (0.08 * 100) * 100 = $200,000. Combining this leg of the trade with the purchased March 13 put lowers the total cost of the entire position to $400,000 -- $600,000 - $200,000 = $400,000.
The addition of the sold March 12 put also lowers breakeven on the trade. To arrive at breakeven, we subtract the credit received from the sold March 12 put from the debit incurred by purchasing the March 13 put. Doing so, we arrive at a cost of $0.16 -- $0.24 - $0.08 = $0.16 -- or $16 per pair of contracts. As a result, breakeven for the position now rests at $12.84 per share, with the trader now needing DELL to fall roughly 8.8% from Monday's close.
The maximum profit on the combined legs of the long vertical put spread is calculated by subtracting the total debit paid from the difference between the sold March 12 strike and the purchased March 13 strike. In this case, the maximum profit is $0.84 -- (13 - 12) - $0.16 = $0.84 -- or $84 per pair of contracts, and is reached if DELL drops to $12 per share when the options expire. Below is a chart for a rough visual representation of the trade's profit/loss scenario:
After a vertical put spread has been entered, increasing implied volatility is usually 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 March 13 put arrived at 36.33%, while the implied volatility for the March 12 put rested at 39.92%. DELL's one-month historical volatility was 21.09%, as of the close of trading on Monday.
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