Analyzing Massive Call Volume on Geron Corporation, By the Numbers

              

As you may have noticed, we keep a close eye on unusual developments in the fast-paced and glamorous world of options trading. Thanks to this diligence, it has not escaped our notice that buy-to-open call volume has absolutely exploded on Geron Corporation (GERN: sentiment, chart, options) during the past couple of weeks. Yes, this surge in optimistic option activity is supported by a positive fundamental development -- but, with everyone piling onto the bullish bandwagon, how long can the stock extend its rally?

FDA decision sparks massive call volume

First things first -- let's explain why GERN is attracting so much enthusiasm from speculative investors. Back on Jan. 23, the stock spiked sharply higher after word hit the Street that the U.S. Food and Drug Administration (FDA) granted its approval for the world's first clinical trial of human embryonic stem cell therapy.

Previously, the agency had rejected Geron's request to conduct a trial of its GRNOPC1 drug. With this regulatory hurdle cleared, investors flocked to buy the stock's call options (apparently, tens of thousands of traders have absolutely no moral qualms about the often-controversial topic of embryonic stem cells).

Lest you think we're exaggerating, let's define what we mean when we refer to "massive" call volume. Year-to-date, about 47,500 calls have been bought to open on the International Securities Exchange (ISE), compared to about 3,700 puts. On Jan. 23 alone, there were about 17,000 calls bought to open and 750 puts bought to open.

Most of the recent call additions have been focused around the February options series, which expires in a couple of weeks. There are 12,189 call contracts in residence at the 7.50 strike, and 10,693 calls open at the 10 strike. The 7.50 call is also the most popular option in the March series, where there are 9,000 open contracts.

Thanks to the FDA-related boost, GERN has rocketed to a year-to-date gain of 62.7%. However, the shares' momentum stalled out near the 8 level, and they're now trading nearly flat with the closely watched 7.50 strike. With February expiration approaching the Friday after next, this region could exert some options-related resistance on the shares during the short term.

In fact, this unfavorable open interest configuration has us a little concerned about the short-term prospects for GERN. Is the equity's rally on its last legs?

Is there any room left on the bandwagon?

We decided to check out the rest of the stock's sentiment backdrop to see if any additional buyers are still lingering on the sidelines. GERN's Schaeffer's put/call open interest ratio (SOIR) has pulled back sharply of late, moving inversely to the equity's powerhouse rally. Now, the SOIR is docked at 0.23, with calls more than quadrupling puts among near-term options. This ratio ranks lower than 78% of other such readings taken during the past year, underscoring the recent upswing in option-player optimism.

While we would expect the SOIR to decline as the stock rises, it's troubling in the context of GERN's recent price action -- which has been primarily sideways. If this heavily bullish group grows discouraged, an unwinding of long positions could apply new selling pressure.

As for short sellers, it seems that short interest on GERN has steadily declined since August 2008. Now, the number of shares sold short is near a 1-year low. However, it's all relative -- this apparently low number still accounts for a healthy 10.9% of the stock's available float, or 10.2 times its average daily volume. These bearish bets represent a potential source of buying pressure for GERN.

Additional attention from analysts could also serve as a positive catalyst, as Zacks reports just 1 "buy" and 1 "hold" rating. Any bullish initiations or upgrades could draw another wave of buyers to the stock.

The long and short of it

While we're encouraged by the respectable amount of short interest on GERN, we're still hung up on the 7.50 level... and, as contrarians, we can't help but be leery of the bandwagon mentality among option players. It seems that some investors have already priced in plenty of upside, which means the security has high expectations to meet.

Additionally, there's no denying that buying power has waned since the stock's initial pop higher. During the short term, traders should keep an eye on the 7.50 strike. If the shares fail to surmount this level during the next week or 2, it could prompt some frustrated bulls to hit the exits, and the equity may even be forced to fill in its bull gap.

On the other hand, a successful journey atop this region could convince the lingering skeptics of GERN's strength, resulting in additional gains. Overall, proceed with caution when it comes to this stem cell concern. The potential for further gains is there, but the stock will have to convince the remaining bears that its rally has legs to run higher.

As always, please contact us with any questions, comments, or suggestions for future columns. For more commentary on today's market-moving news, please visit our Schaeffer's Daily Market Blog section throughout the trading day.