Why calls buyers are going long-term

The stock market has been climbing for almost two years, and now some investors are positioning for continued gains using long-term options.

In recent days, our Heat Seeker monitoring program has detected unusual activity in several names as investors pay a premium for longer periods of upside exposure.

Baxter was the first to trigger our alerts last week when investors bought the August 55 calls for $0.77. The blood-products stock was trading for $48.90 at the time. The shares then proceeded to rise, closing yesterday at $51.71. Those same calls more than doubled over the same period to $1.84.


The successful trade is another example of the flexibility offered by options. On one hand, the investor may have simply wished to lock in a long-term entry price but was not yet ready to buy. Or the trader may have sought to use the leverage afforded by options to magnify a move in the share price.

After all, BAX climbed only 5.7 percent. Earning a similar return without the calls would have entailed borrowing a huge amount of money to buy millions of shares. That almost certainly would have driven up the stock price long before the position was fully established. Unloading it would have been equally difficult.

Similar trades appeared in other names yesterday as bulls widened their use of the strategy. The first was in Colgate-Palmolive, which gapped higher amid takeover speculation last week. Since then it has held those gains and started moving again. Investors stepped into the August 90 calls, paying $0.69 and $0.70 before bidding premiums up to $0.75.

Given the long time until expiration, the trade can profit even if CL remains below the strike price. For instance, delta on the calls was 0.13, which means that they will appreciate by $0.13 for every $1 that the underlying stock advances. So if CL climbs just 7.6 percent to $85 in the next few weeks, those calls will more than double in value.

They will also benefit from the fact that delta increases as contracts move closer into the money, another benefit of purchasing long-term options. The drawback is that investors must pay more in time value, which can erode their investment to zero if the shares fail to move as hoped. (See our Education section)

DirecTV is contending with long-term resistance dating back to the tech bubble in March 2000. It's been grinding at this level since the autumn, and yesterday the Heat Seeker detected the purchase of more than 16,000 September 55 calls. Most of them priced for $0.27.

Similar trades were also identified in Nasdaq OMX Group, which has been surging lately amid takeover speculation in the financial-markets sector, and Blackstone, which has been rallying on optimism about the credit markets and real-estate prices.

Disclosure: I own BX shares.

(Chart courtesy of tradeMONSTER)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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