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A Look at the Long Call Spread, Courtesy of Atlas Energy LP (ATLS)

Breaking down a massive long call spread on ATLS

by 4/25/2014 9:38:13 AM
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Atlas Energy LP's (NYSE:ATLS) saw unusually robust action in its options pits earlier this week. Specifically, a two-legged spread was employed across a pair of long-term, out-of-the-money strikes, and consisted of 40,000 total contracts. In a nutshell, the speculator in focus established long and short call positions in order to bank on a significant advance in the shares by January 2015 options expiration.

Diving into the details, the trader bought to open 20,000 January 2015 50-strike calls -- near the ask price, at $1.45 each -- while simultaneously selling to open a matching block of January 2015 60-strike calls -- near the bid price, at $0.30 apiece. In so doing, this individual paid a net debit of $1.15 per pair of contracts in order to initiate the long call spread (also known as a bull call spread). This amount represents the trader's maximum potential loss per pair of contracts. After accounting for the size of the deal, the total risk works out to $2.3 million ($1.15 net debit * 20,000 contracts * 100 shares per contract).

Getting back to the strategy, breakeven on the trade is $51.15, or the long strike plus the initial net debit. In order to reach this mark, ATLS shares -- which were hovering at $41.05 at the time of the trade -- will need to gain roughly 24.6% in the next nine months or so. With each step north of breakeven the underlying takes, the speculator will reap additional profits. However, by selling the 60-strike calls to open -- which lowered the trader's cost of entry, relative to a "vanilla" long call strategy -- he capped his potential gains. In other words, this individual's potential profit will max out once ATLS hits the upper strike, even if the shares rally beyond it.

Consequently, the trader cannot make more than $8.85 per pair of contracts (the difference between the strikes, less the initial net debit), or $17.7 million total ($8.85 * 20,000 contracts * 100 shares per contract). While this pales in comparison to the theoretically unlimited upside of a straight call-buying strategy, the trade-off involved in selling the higher-strike calls makes more sense in light of ATLS' price history. Since going public in 2006, the stock has never traded north of $55.89 -- a mark that it hit last October. In fact, delta on the 60-strike call currently sits at 0.07, representing a mere 7% chance that the equity will be trading above the strike at expiration.

At the same time, this long call spread still offers the potential for plenty of return on investment. Specifically, based on the initial cost of $2.3 million and the maximum possible profit of $17.7 million, the speculator could earn up to a 670% return for his investment in Atlas Energy LP (NYSE:ATLS).

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