The lack of news surrounding Genworth Financial Inc. (GNW: sentiment, chart, options) lately hasn't deterred options traders from flooding the equity with activity today. In fact, the stock has shown up on our Intraday Volume Explosion List for both calls and puts. Specifically, put volume has spiked to more than 10,000 contracts, or roughly eight times the security's daily average, while call volume has ballooned to more than 20,000 contracts, or about 4.6 times GNW's daily average.
The most active put on the session is the October 7 strike, with some 10,000 contracts changing hands. Meanwhile, both the October 10 and 13 calls have seen volume in excess of 10,000 contracts. Open interest for all three strikes rests well below today's volume, indicating that we could see a rise in open positions for these options.
Oddly enough, after a little digging, I discovered that nearly all of this activity was part of a larger spread trade on GNW. At about 10:26 a.m. Eastern time, 10,000 October 7 put contracts traded on the NYSE Arca for the bid price of $0.40, or $40 per contract. At the same time on the same exchange, the October 10 call saw 10,000 contracts trade for the ask price of $0.90, or $90 per contract, while another 10,000 October 13 calls traded for the bid price of $0.20, or $20 per contract. Furthermore, all of these contracts were marked "spread." Given this data, we could be looking at the initiation of a bullish debit spread on Genworth Financial.
The Anatomy of a Genworth Financial Debit Spread
Breaking down this debit spread position, the trader would have received a credit of $400,000 for selling 10,000 GNW October 7 puts -- (0.40 * 100) * 10,000 = $400,000. Another credit of $200,000 was received for selling 10,000 October 13 calls – (0.20 * 100) * 10,000 = $200,000. Finally, the trader purchased 10,000 October 10 calls for a total outlay of $900,000 -- (0.90 * 100) * 10,000 = $900,000.
Minus the sold legs of the debit spread, GNW would need to rally about 19.3%, from yesterday's close at $9.14 per share, to $10.90 per share in order for the position to reach breakeven at expiration. Furthermore, the maximum loss on just the purchased October 10 calls is limited to the initial investment of $900,000.
By selling the October 7 puts and the October 13 calls, however, the trader has offset the cost of the overall position. Adding in the credit received for selling these options lowers the total cost of the entire position to $300,000 -- $900,000 – ($400,000 + $200,000) = $300,000.
The addition of the sold October 7 put and the October 13 call also lowers breakeven on the trade. To arrive at breakeven, we subtract the credit received from the sold options from the debit incurred by purchasing the October 10 call. As such, we arrive at a cost of $0.30 – $0.90 – ($0.40 + $0.20) = $0.30 -- or $30 per contract. Breakeven for the position now rests at $10.30 per share, a rally of about 12.7% from Thursday's close.
The maximum profit is calculated by subtracting the total premium paid from the difference between the two call strikes, and is reached if GNW rallies to $13 per share at expiration. In this case, the maximum profit is $2.70 -- (13 - 10) - 0.30 = $2.70 -- or $270 per contract. The maximum loss can be considerable, but is limited to October 7 strike plus the premium paid to enter the position. In this case, the maximum loss is $7.30 -- 7 + 0.30 = $7.30 -- or $730 per contract. Below is a chart for a rough visual representation of the trade's profit/loss scenario:
Implied Volatility
Rising implied volatility can be detrimental to this position if GNW moves above the sold put or call strikes, making these options more expensive to repurchase. Otherwise, a jump in implieds is beneficial to the trade, as it lifts the value of the purchased October 10 call. Currently, implieds for the October 7 put arrive at 110%. Meanwhile, implied volatility for the October 10 call rests at 101%, while implieds for the October 13 call come in at 96%. GNW's two-month historical volatility is currently perched at 90.24%, meaning the aforementioned options are expensive at the moment.
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