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AOL Targeted for Skeptically Skewed Options Spread

AOL traders are picking up calls and puts at the August 33 strike

by 7/12/2012 1:46 PM
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Short-term option premiums on AOL, Inc. (NYSE:AOL - 27.60) are relatively inexpensive at the moment, which could've prompted a two-pronged volatility play ahead of earnings on Wednesday, July 25. In fact, the stock's Schaeffer's Volatility Index (SVI) now sits at an annual low of 16%, suggesting now is an opportune time for option buyers to gamble on the stock's near-term trajectory.

So far today, AOL has seen roughly 7,100 calls and 6,800 puts change hands, far surpassing its average intraday volume of about 1,400 calls and 1,800 puts. Upon closer inspection, we find that nearly all of the action has centered on the August 33 strike, which has seen 6,440 contracts traded on each side of the tape. What's more, the majority of the volume has consisted of symmetrical blocks marked "spread," with the calls crossing for an average ask price of $0.08, and the puts traded for an average ask price of $5.62. Plus, volume has outpaced open interest on both sides, pointing to the initiation of a bearishly biased long straddle strategy.

In a nutshell, the speculator is pessimistically positioned, as evidenced by his purchase of deep in-the-money puts. However, to hedge his bets in the wake of a significant post-earnings rally -- and since option premiums are so low -- he simultaneously bought the out-of-the-money calls. This bearish bias is also evidenced by the straddle's breakeven rails. In order to profit, the investor needs AOL to perforate one of two levels within the options' lifetime: the $27.30 level on the downside (strike minus net debit of $5.70), which is just a hair's breadth from AOL's current price, or the $38.70 level (strike plus net debit), which would require a 40% jump into all-time-high territory. Nevertheless, the most the trader stands to lose is limited to the net debit of $5.70.

From a wider sentiment standpoint, AOL is no stranger to skepticism in the options pits. The stock has racked up a 10-day put/call volume ratio of 6.08 on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), indicating that traders have bought to open more than six puts for every call during the past couple of weeks. What's more, this ratio sits just six percentage points from an annual high, suggesting investors are initiating pessimistic positions at an accelerated clip.

In the same vein, the security's Schaeffer's put/call open interest ratio (SOIR) of 0.87 registers in the 86th percentile of its annual range. In other words, short-term option players are more put-heavy than usual at the moment.

At last check, AOL has shed 1.1% to wink at the $27.60 level.


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