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This Groupon Rally May Be Short Lived

Traders are selling overhead GRPN calls, banking on limited upside

by 11/21/2012 3:11 PM
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As Schaeffer's' contributor Adam Warner noted on Twitter earlier today: "[Groupon is] up 28% this week! ... OK, they also note it's down 83% overall." Groupon Inc (NASDAQ:GRPN - 3.86) has indeed had a great holiday-shortened week, but how high can the stock bounce? And for how long? Some options players aren't so sure, and are expressing this skepticism via a long-term short call position.

When the stock was trading around $3.60, a 10,000-contract block changed hands on the July 4 call and went off at the bid price of $0.70 per contract. This appeared to be part of a buy-write strategy -- similar to a covered call -- where the investor buys shares of the underlying stock and simultaneously sells a corresponding number of call contracts. This strategy caps future upside at the strike price but also amplifies the potential payout, as the trader collects a credit for selling the call and participates in the stock's upside between the purchase price and the sold strike.

If the stock rallies, as GRPN has done today (up a whopping 14%), the only real downside for a covered call seller is lost opportunity (as the upside in the stock is capped). If the calls are not covered, however, the loss potential is unlimited as the stock advances. As an example, the July call sold today for a $0.70 credit quickly ramped to an ask price of $1.00, making buying to close a pricey proposition.

Broadening the scope, calls have been the option of choice on this low-priced Wall Street rookie, but typically with buyers in control. During the last 10 days, 343 calls have been bought to open for every 100 puts at the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). This ratio is higher than all but 8% of the past year's worth of readings, suggesting long call speculation is near an annual peak in the wake of the stock's recent upside.

A few days ago, in fact, option speculators bet on the 11/23-dated 3-strike calls and won big. The stock spiked higher yesterday after a hedge fund disclosed a large stake in the beleaguered online-coupon name.


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