Bearish options traders are beginning to gain momentum on Companhia Vale do Rio Doce (VALE: sentiment, chart, options). The stock's Schaeffer's put/call open interest ratio (SOIR) has steadily risen from its April 30 low of 0.63 to its current perch at 0.70. However, the current reading ranks in the 67th percentile of its annual range, indicating that put trading has yet to become crowded. Today's options speculators are continuing this preference for puts in the wake of the company's first-quarter earnings report.
For the record, VALE said that first-quarter earnings fell 32.6% to $1.363 billion, or 26 cents per share, from $2.021 billion, or 41 cents per share, a year ago. Revenue also fell by 32.6%, to $5.421 billion, from $8.048 billion in the same period a year ago. Earnings before interest, taxes, depreciation and amortization fell 39%, to $2.281 billion, from $3.729 billion.
Returning to the options pits, VALE's June 18 put (.RIORH: sentiment, chart, options) is the equity's most popular option today by far. The front-month strike has seen nearly 20,000 contracts cross the tape so far, with open interest totaling just 7,889 contracts. By comparison, the September 15 put has seen more than 9,000 contracts trade, with open interest totaling 11,058 contracts.
Diving into the June 18 put, I noticed that a large block of 10,000 contracts changed hands at 10:10 a.m. Eastern time. The block traded at a price of $1.26, near the middle of the bid/ask spread of $1.23 and $1.28, respectively. In an attempt to discern whether these contracts were bought or sold to open, as they are most likely new positions given the discrepancy between volume and open interest at this strike, we turn to our option pricing calculator and the stock's implied volatility.
Implied Volatility
By filling in the fields on the option pricing calculator, we can determine the implied volatility at the time of the trade, and thereby make an educated guess as to whether this block was bought or sold to open. After entering the company's ticker, the stock's price at 10:10 a.m., and the company's quarterly dividend, we arrive at an implied volatility of 53.777% for the VALE June 18 put at the time of the trade.
Comparing this with the option's implied volatility of 58% from yesterday, we can see that implieds have dropped on the June 18 put. This suggests that this block of contracts was potentially sold to open, or the initiation of a put-sell position. What's more, the fact that implieds for the June 18 put arrive well below the stock's two-month historical volatility of 61.76% indicates that the trader is selling cheap options. Furthermore, the act of selling these options could be suppressing these implieds.
The Anatomy of a Vale Put-Sell Position
Assuming that the block of 10,000 VALE June 18 puts were sold, the trader would receive a total credit of $1,260,000 -- (1.26 * 100)*10,000 = $1,260,000. In order for the trader to retain the entire premium received, the equity needs to stay above the 18 level through June 15, when these options expire. The theoretical maximum loss on this position is limited to the difference between the premium received and the sold strike, or $1,675 per contract, if the stock goes to zero. Finally, breakeven is equal to the sold strike minus the premium received, or $16.75 per share.
Below is a chart for a visual representation of returns for a sold VALE June 18 put:
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