Credit: Shutterstock photoShares of semiconductor equipment maker Applied Materials Inc. ( AMAT ) have pulled back sharply this week, with the sell-off in the broader market pushing the equity down for a test of long-term support in the 12 region. AMAT has not closed a week below this area since July 2009. Whether due to the stock's pullback to this long-term support level, or another set of indicators, one options trader placed a trade earlier this morning that is designed to take advantage of a potential rebound.
Overall, AMAT's options volume has been centered on the call side of the coin, with more than 6,300 contracts changing hands on the session, more than tripling the stock's daily average. The most popular strike has been AMAT's July 12 call, where some 3,800 contracts have traded, while the July 13 call came in at a close second in terms of volume.
Amid the July 13 strike volume was a block of 380 July 13 calls, marked "spread." This block traded at 10:05 a.m. Eastern time on the International Securities Exchange ( ISE ) for the bid price of $0.05. The second half of this spread took place on AMAT's July 12 call, where 380 contracts traded at the same time on the same exchange for the ask price of $0.38. Given this data, it would appear that we are looking at a vertical call spread, more commonly known as a debit spread , on Applied Materials. This options strategy is also known as a long call spread, or a bull call spread.
The Anatomy of an Applied Materials Vertical Call Spread
Breaking down this debit spread, the trader purchased 380 July 12 calls for the ask price of $0.38, resulting in a debit of $14,440 -- (0.38 * 100) * 380 = $14,440. In the absence of the premium received by selling the July 13 call, the trader would need AMAT to rally nearly 3% from Wednesday's close, to $12.38 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 $14,440.
As you can see, the second leg of the debit spread helps to offset the cost of the overall position. In this case, the trader sold 380 July 13 calls for the bid price of $0.05, netting a total credit of $1,900 -- (0.05 * 100) * 380 = $1,900. Combining this leg of the trade with the purchased July 12 call lowers the total cost of the entire position to $12,540 -- $14,440 - $1,900 = $12,540.
The addition of the sold July 13 call also lowers breakeven on the trade. To arrive at breakeven, we subtract the credit received from the sold July 13 call from the debit incurred by purchasing the July 12 call. We arrive at a cost of $0.33, or $33 per contract. As a result, the trader now needs AMAT to rally roughly 2.7%, to $12.33, in order to recoup the initial investment on the entire position.
The maximum profit is calculated by subtracting the premium paid from the difference between the two strikes, and is reached if AMAT rallies to $13 per share at expiration. In this case, the maximum profit is $0.67 -- (13 - 12) - 0.33 = $0.67 -- or $67 per contract. The maximum loss is equal to the net debit of $0.33, or $33 per contract. Below is a chart for a rough visual representation of the trade's profit/loss scenario:
Implied Volatility
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 July 12 call were 39.37%, while the implied volatility for the July 13 call was 33.18%. For comparison, AMAT's one-month historical volatility was perched at 34.93% as of the close on Wednesday.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
