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SUPERVALU Straddle Trader Targets Moderate Upside

A September-dated short straddle was constructed on SVU

by 8/17/2012 11:10 AM
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Both calls and puts were trading at accelerated levels on SUPERVALU INC. (NYSE:SVU - 2.42) in Thursday's session. Around 10,000 call contracts crossed the tape, representing nearly two times their average intraday pace. By comparison, roughly 8,700 put contracts changed hands, which is 1.2 times the expected daily volume. One trade that caught our eye was an out-of-the-money call and put combination that looks like a short straddle trade.

On a technical basis, SVU has given up a hefty 70.2% of its value year-to-date, and has underperformed the broader S&P 500 Index (SPX) by more than 50 percentage points over the past three months. The shares took a dive on the heels of a poor fundamental showing back in mid-July, and dropped to a record low of $1.68 on July 25. Since then, the stock rebounded into the $2.20-$2.60 neighborhood, where it has been trading since the beginning of August.

Taking a closer look at yesterday's options activity, we see that one options player believes SVU will turn higher in the near term, and may have implemented a short straddle in the soon-to-be front-month September series of options. Specifically, two blocks totaling 6,750 September 4-strike puts crossed the tape at the bid price of $1.60, while two symmetrical blocks of September 4-strike calls changed hands at the bid price of one penny. A net credit of $1.61 was established.

In the best-case scenario, SVU will be trading at the $4 area by September expiration, allowing both the sold call and sold put to expire worthless. Should this occur, the spread strategist would pocket the initial premium collected, which is also the maximum potential profit for the play. But the trader could still benefit as long as the stock remains between the two breakeven levels at $2.39 (strike price less the net credit received) and $5.61 (strike price plus the net credit received). Should the shares move significantly in the interim, losses are theoretically unlimited to the upside and are unlimited down to zero on a downside move. If the stock is below $4 when the straddle expires, the put seller will likely be assigned and have to fulfill his obligation to buy SVU at the strike price, no matter where the stock is trading.

This strategy is a bit puzzling, given the far out-of-the-money call worth only one penny. One wonders why the trader didn't merely buy calls outright, if he expects the stock to reach $4 by the end of September. Possibly because he wanted the collect the initial credit, some of which he keeps even if the stock doesn't move from current levels. In exchange for a enjoying wide span where the trade is profitable, though, the straddle seller faces potentially unlimited losses. Sometimes there is no rationale behind options strategies -- at least not that the outsider can discern.

Yesterday's overall preference toward SVU calls is just business as usual for the grocer, which dons a 10-day International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) call/put volume ratio of 4.95. However, there could be a less-than-bullish reason for this call-heavy activity. Short interest accounts for a hefty 44.1% of the equity's available float. Oftentimes, short traders will buy calls as hedges for their bearish bets -- and this could be what's happening here.

At last check, SVU is off about 1%, hovering arounf the $2.40 level.


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