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Arch Coal Inc (ACI) Drop Inspires Gutsy Option Play

One ACI option trader buys a synthetic long stock using August options

by 6/24/2013 1:40 PM
Stocks quoted in this article:

Option players are taking advantage of today's pullback in Arch Coal Inc (NYSE:ACI) to place speculative bets on the foundering name. First, put volume is running at roughly six times what is typically seen on an intraday basis (with about 12,000 puts changing hands). Some investors may be opting for this route as ACI is on the restricted list for short sellers. Meanwhile, roughly 15,000 calls have changed hands, quadrupling what is typically seen in ACI options pits.

One trader apparently used a combination of calls and puts to open a synthetic long stock trade that bets on a near-term recovery in the shares. Specifically, he bought to open a block of 5,000 August 4 calls above the ask price at $0.28 per contract, and sold to open a block of 5,000 August 3 puts below the bid price, at $0.16 per contract. Open interest at both of these strikes was zero heading into today's session, as this strike was just opened with the expiration of June options. With the stock currently perched at $3.54, both the call and the put are out of the money.

In order for the strategy to be profitable at expiration, ACI needs to be trading north of $4.12, or the call strike plus the net premium paid. Above this level, the value of the two-legged spread will appreciate in lockstep with the stock itself. Because the strikes are "split," losses are capped at the $0.12 debit, should ACI be trading between the two strike prices at expiration. Finally, south of the $3 level, losses will appreciate until the stock hits zero.

As Karee Venema pointed out on Friday, Arch Coal has been a favorite among call players, despite the stock's lackluster price action. Year-to-date, the shares have dropped close to 52%, hitting a new multi-year low of $3.47 today. During the last 10 trading days, though, more than nine calls have been bought to open for every put on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). The resultant call/put volume ratio of 9.38 ranks higher than 85% of similar readings from the past 12 months.

Arch Coal Inc (NYSE:ACI) and other names in the coal business are dropping today after the U.S. Supreme Court said it would review the Environmental Protection Agency's clean-air proposal to reduce power-plant emissions. This regulation is seeing the light of day again after previously being squashed in a federal appeals court.


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