Stocks quoted in this article:
Upbeat construction spending data released yesterday by the U.S. Commerce Department created a flurry of options trading around The Home Depot, Inc. (NYSE:HD - 69.95), which has burst out of the gate this morning. Total options volume on the home improvement retailer was three times its normal levels in Monday's trading, with 38,000 calls and 32,000 puts changing hands. Nearly two-thirds of that volume was because of one trader looking to take advantage of all the commotion with a long volatility play.
The investor executed a long strangle, which is relatively neutral on which way the stock is headed but is very bullish on a sizable move in either direction. According to data from Trade-Alert, one trader bought 20,000 May 70 calls to open for $1.68 apiece at the same time they bought 20,000 May 67.50 puts for $0.84 each. Both strikes saw heavy open interest additions overnight.
So the trader makes a profit if Home Depot climbs above $72.52 (call strike plus the combined premium of $2.52) by expiration, or if it falls below $64.98 (put strike minus the combined premium). If the stock is still trading between the purchased strike prices on the expiration date of May 17, this investor only loses the net premium paid.
The massive strangle was tied to a large stock position, which may have been the investor's bargaining chip for securing a better entry price. Occasionally, large-scale traders will assume all delta risk personally, giving the market maker on the other side of the trade a reason to offer a more attractive entry price on the options. Once the option trade has been processed, the trader will exit the stock position.
If Home Depot keeps on its current pace, the trader's best bet might be to the upside. HD is up 12.6% so far in 2013, and has climbed steadily over the last 18 months, hitting an all-time high of $71.45 on March 8. It is also up nearly 40% as compared with last April, and is closing in on analysts' consensus 12-month price target of $73.30 -- with future upgrades poised to possibly push the stock higher.
Sentiment among options traders is at a bullish peak on the stock as well, with the 10-day call/put volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) at 3.02. Not only does that mean traders are buying calls to open at triple the pace of puts, but that is the highest reading in the last 12 months -- indicating that calls are as popular now as they have been all year.