Stocks quoted in this article:
Option volume on Cognizant Technology Solutions Corp (NASDAQ:CTSH) was significantly higher than usual yesterday. Over the course of the session, roughly 17,000 contracts changed hands, or more than 2.5 times the expected volume.
More than half of the total volume can be traced to a two-legged transaction that occurred just after 12:30 p.m. ET. A single speculator simultaneously traded 4,500 CTSH October 80 calls at the bid price of $0.50 each -- indicating they were sold -- and an identically sized block of October 70 puts near the ask price -- indicating they were purchased -- for $1.63 each. As Trade-Alert indicates the option trades were tied to stock -- and because open interest at both strikes spiked overnight -- this was an apparent collar strategy.
Based on the figures quoted above, the option player entered into the position for a net debit of $1.13 per pair of contracts -- that is, the difference between the $1.63 premium paid, and the $0.50 premium received. Because the shares traded for $73.20 per Trade-Alert, the breakeven price is $74.33 (stock price plus net debit paid).
In terms of maximizing profit potential, the trader wants the shares of Cognizant Technology Solutions to reach the higher strike price by options expiration, without going above it -- lest he be required to deliver the shares for $80 each. (In other words, any gains in the underlying stock are relinquished north of $80.) Thus, the most that can be pocketed is $5.67 ($80 - $73.20 - $1.13) per collar. Conversely, downside is capped once CTSH sinks below the lower strike price -- in dollars and cents, that's $4.33 ($73.20 - $70 + $1.13).
Given that the equity has gained nearly 20% since hitting an annual low in late June, this strategy may have been established as a hedged play. Profits are limited due to the short call, but losses are also limited, thanks to the sold put. Currently, the shares of Cognizant Technology Solutions Corp (NASDAQ:CTSH) are modestly higher from yesterday's close, at $73.88.