Driven by resurgent gold prices , the shares of Kinross Gold Corp. ( KGC ) have once again rebounded from long-term support at the $15 level today. In fact, KGC has closed only two weeks below $15 since December 2008. What's more, the April gold futures contract has soared some $19.60 to $1,429 an ounce on the session, providing rally fuel for gold-mining related stocks .
Options traders have jumped on KGC today, with both calls and puts attracting a wealth of activity. On the put side, some 2,260 near-term contracts have changed hands, more than quadrupling the stock's average daily put volume. Meanwhile, a whopping 24,000 calls have crossed the tape, outstripping KGC's average daily near-term call volume by a factor of more than nine to one. Taking a closer look at this call activity reveals that one trader is responsible for practically all of today's volume so far.
Specifically, 10,000 May 17 calls traded at about 10:28 a.m. Eastern time on the American Stock Exchange (AMEX). These contracts crossed at the ask price of $0.60, or $60 per contract, and were marked "spread." At the same time, 10,000 May 19 calls, also marked "spread," changed hands for the bid price of $0.20, or $20 per contract. The end result is a vertical call spread, more commonly known as a debit spread , on Kinross Gold.
The Anatomy of a Kinross Gold Vertical Call Spread
Breaking down this debit spread position, the trader purchased 10,000 May 17 calls for the ask price of $0.60, resulting in a debit of $600,000 -- (0.60 * 100) * 10,000 = $600,000. In the absence of the premium received by selling the May 19 call, the trader would need KGC to rally roughly 12.5% from Thursday's close at $15.64, to $17.60 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 $600,000.
By entering the second leg of the debit spread, the trader has offset the cost of the overall position. In this case, the trader sold 10,000 May 19 calls for the bid price of $0.20, netting a total credit of $200,000 -- (0.20 * 100) * 10,000 = $200,000. Combining this leg of the trade with the purchased May 17 calls lowers the total cost of the entire position to $400,000 -- $600,000 - $200,000 = $400,000.
The maximum profit is calculated by subtracting the net premium paid from the difference between the two strikes, and is reached if KGC rallies to $19 per share at expiration. In this case, the maximum profit is $1.60 -- (19 - 17) - 0.40 = $1.60 -- or $160 per pair of contracts. The maximum loss is equal to the net debit of $0.40, or $40 per pair of contracts. Below is a chart for a rough visual representation of the trade's profit/loss scenario:
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 May 17 call arrived at 36.25%, while the implied volatility for the May 19 call came in at 36.79%. For comparison, KGC's three-month historical volatility arrived at 30.51% as of the close on Thursday.
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