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Not everything is as it seems, or so Owens Corning (OC - 27.9) options activity taught me this morning. On Friday, I noticed two blocks of OC puts trading – the higher strike off the bid price and the lower strike off the ask. I hastily concluded this was likely a bull put spread, executed by traders expecting OC to move slightly higher through the next month. But existing open interest made this theory inconclusive, and this morning's open-interest translations proved me wrong.
It looks as though traders were actually selling July 28-strike puts to close and buying July 25-strike puts to open. In other words, the expectation is that OC shares will drop south of $25 before July options expire in five weeks. More than 3,000 puts were added at the 25 strike (at an average purchase price of $0.75); the 28 strike saw its open interest decline by more than 1,000 contracts as traders sold out of their positions for an average price of $1.65.
Meanwhile, more than 2,600 contracts were added at the July 26 put. These were likely purchased as well, as 73% of Friday's volume went off at the ask price. The average per-contract cost of these out-of-the-money puts was $1.01.
Breakeven (at expiration) for a long put is the strike price less the premium paid. In the case of the July 25 puts, breakeven is $24.25; for the July 26 puts, it is $24.99. Long put buyers stand to lose 100% of the premium paid if the shares are not trading south of breakeven when expiration rolls around. Gains, on the other hand, are unlimited down to zero if the stock churns lower.
For the past couple of years, OC has been drifting sideways in a range loosely defined by $25 to the downside and $35 to the upside. While largely unchanged for 2012 (down 2.5%), OC shares have lost 24% in the past three months and underperformed the S&P 500 Index (SPX) by almost 19% during this same timeframe.
The sentiment picture on OC is mixed, with analysts keeping a positive attitude while short-term options players are huddled on the bearish side of the playing field. From the dozen analysts following the shares, OC has netted seven "strong buy" ratings and three "buys." What's more, the average 12-month price target of $38.18 is an optimistic 36% above the stock's current price.
Activity in the options pits, however, has been put-heavy, just like we saw on Friday, when put volume ran four times ahead of average. The Schaeffer's put/call open interest ratio (SOIR) for OC is at an annual high of 1.85, meaning there are 185 open puts for every 100 calls in the front three months' series. Also, in the last 10 trading days on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), nearly 12 puts have been bought (to open) for every call. The resultant put/call volume ratio of 11.33 is higher than 93% of the past year's readings, suggesting that put volume has been running at an accelerated pace.