Investing in Options: Seller Makes $455,000 in 9 Days

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Not only does the article tell the story of how the option trader did it, but also gives you the trade he is in right NOW.

One thing I want to point out is that this trade had very little risk for this trader. Why? Because it seems that the trader was bullish on the stock and thus would have bought the shares had they gone down. So basically he would have gotten a discount on them as well as have the ability to buy them below what their “value” was.

Fun With Options: Trader Pockets $455K on Walgreen

Published: Wednesday, 29 Sep 2010 | 9:53 AM ET by Jeff Cox

Some (options) guys (or girls) have all the luck.

Investing in Options: Seller Makes $455,000 in 9 Days
Nick Ut / AP

Well, at least one of them has had a tremendous amount of good fortune lately by playing long and short positions against each other on drug store chain Walgreen and pocketing nearly half a million dollars in profit.

This particular trader’s good fortune began back on Sept. 20 when he or she sold 35,000 put options at the October $27 strike price for an average premium of 17 cents apiece on a day when the stock closed at $29.24, according to information from Interactive Brokers.

The move to sell the puts looked extremely smart Tuesday, when Walgreen posted earnings of 49 cents a share that beat the consensus by a nickel. Shares gained 11.4 percent on the day to close at $33.81, a 15.6 percent jump in eight days.

Investing in options

The stock move hammered the puts, allowing the investor to buy back the options at a 4-cent premium per contract. The net gain, then, was 17 cents per contract, bringing the profit on the 35,000 contracts to $455,000.

Not stopping there, the investor then jumped on the bullish Walgreen bandwagon by rolling the puts to the $31 October contract for a premium of 14 cents per. That means the stock will only have to hold that level through the expiration to keep the full premium.

The cagey positioning was part of an active day for Walgreen in which more than 124,000 contracts were exchanged by mid-day, Interactive Brokers said.

Happy trading, for sure.

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  1. Kim on October 4, 2010 at 12:27 pm

    As one of the comments in the original article mentioned, based on a basic margin requirement for uncovered put selling you would have to have $10,045,000 in your account, cash. So the return on margin was less than 5%.

    What is even worse about this article is it didn’t discuss the huge risk and downside to this trade. As another poster described, the margin requirements and potential wiping out of an account on such a stupid, one-sided non hedged move like this is tantamount to suicide.

    • Rick on October 4, 2010 at 7:28 pm

      5% in 9 days is still not shabby.

  2. Lee Grey on October 4, 2010 at 12:49 pm

    It smells like insider trading to hold that position through an earnings announcement. He’ll probably write a book in prison. And Michael Douglas will play him in the movie.

  3. L.G. on October 4, 2010 at 1:09 pm

    If this trader were so smart or psychic, he should have purchased a pile of WAG out-of-$ Calls – for a few cents premium / share.
    Risk is only the purchase option cost.
    Calls would have increased significantly in value even if still out-of-$ after report.

    Selling a pile of cheap out-of-$ Put options before an earning report is a stupid, high-risk tactic.

    He could also have purchased a strangle of both O-O-$ Calls and O-O-$ Puts for a few cents/share.
    Example Buy Oct. $30 Calls & $25 Puts – cheap.
    (or pick two other strike prices above and below the actual stock price)
    This would have turned a net profit on any up or down big move after the earnings report – with only a small risk of the purchase cost.

    • Genius on October 4, 2010 at 1:32 pm

      Actually I think that this person would have been very happy buying the stock. Since this was a naked put the downside was that the stock would have to be bought at $27 which is $2.25 or 9% higher than where it was trading on that day. If you look at a graph you see the stock gapped higher on earnings. So yes, mayber there was some inside information being shared or else this person really did his homework.

      Or else this trade was a way to hedge another trade. Could this person be a market maker in WAG? Maybe.

      There is more to it than meets the eye and this article does not give us all the details because – well there is no way to know what was going through this person’s mind unless he tells us.

      It’s pretty arrogant to call this a stupid trade without knowing all the details.

  4. Larri on October 4, 2010 at 1:28 pm

    As a naked put seller, I was interested in your article.
    It would hae been more interesting, however, if you had not made an error in your calculations.

    You said that the investor got a premium of $.17 for his
    35,000 $27 contracts, and bought them back for
    $.04. His profit was therefore $.13 a share, not $.17 a share. Your conclusion, however, was correct, except that you didn’t mention the commissions, which, with 35000 contracts was huge.

    • Genius on October 4, 2010 at 1:39 pm

      You are right and wrong. In the article the amount of profit is correct, but the amount made per contract is listed at .17 when it should be .13

      $13 times 35,000 is $455,000 and with this being an institution, I doubt they pay the same commissions we do. 🙂

  5. Raj Iyer on October 4, 2010 at 1:42 pm

    I feel that selling put options before earnings report is not a very smart strategy. If the person had conviction that the earnings report will be bullish on the stock, a less risky way to leverage is to sell out of the money calls. For the last 5 years or so, I never buy the stocks I want to own, directly, but will simply sell naked puts on a down day for the stock. Being a small time player, I only sell very few puts, for which I have the buying power for the stock, if the stocks were put to me.

  6. Kim on October 4, 2010 at 2:48 pm

    The only time it makes sense to sell naked puts is when you are ready to own the stock. In this case, if stock went to $25-26, he would own 3,500,000 shares of WAG at “huge” discount of 17 cents.

    To say that this was a stupid trade is not arrogant. It is actually understatement. Saying that the trader made 455,000 without mentioning huge margin requirements for the trade is extremely misleading. Saying that this trade had very little risk is even more misleading.

    • Genius on October 8, 2010 at 10:00 am

      I said it was arrogant because we know who this trader was or what his situation was. If he can put up the millions required for margin in this situation I don’t think he would have trouble buying WAG stock. Especially since he showed that he was bullish since he rolled the puts up to play the second event (sales store sales data) just a few days later.

      Somehow, I get the feeling that a trader will millions of dollars at his disposal to trade, who probably does this full time, who works for a large institution, (there’s no way this guy was trading his own account), would know a little bit more about trading options than the average individual investor or the opinionated people on this blog.

  7. Ed on October 4, 2010 at 7:05 pm

    Kim, Exactly. Earnings are the worst time to play options, I know from experience. What if Walgreens didn’t meet earnings? And even if a company meet/beat, the stock can tank.

    • Genius on October 8, 2010 at 9:54 am

      Ed, options are just a tool. If you know how to wield the tool you can use it in different situations. It’s not that you cannot use options to play earnings. Many time options are awesome to play earnings. That’s when volatiity is at its highest. I will give you an example. Apple normally has earnings a few days before expiration. That means that the options of that month will keep their value until earnings and then basically go to zero the day after because all the vol comes out. (I’m talking out of the money here). So a calendar spread would and does work wonderfully.

      You need to do your homework and know how much apple usually moves at earnings and set up your trade accordingly – maybe a double or even a triple calendar, but I know some traders that play this religiously and do very well. You always know your risk going in, but the gain can be 30-40% and sometimes more.

      • Kim on October 8, 2010 at 10:33 am

        Allen, I completely agree with you here. Multiple calendars is an excellent way to play earnings. They can produce 20-30% gains, and even if the stock has a big move, you can usually get out with fairly small loss. Most of the time front month options are overpriced before earnings. But the point is that your risk is pre-defined and even if you are wrong, in most cases you will have only moderate loss. This is not the case with naked puts where you risk a very big loss for less than 5% gain. The fact that this is institutional trader doesn’t change the facts. I followed so called “smart money” many times, their winning rate is not so great as you would think.

  8. Steve on October 4, 2010 at 10:54 pm

    Hey Kim,

    I’ll take a 5% return over a 2-week time frame any day. Do the math: That works out to a 125% annual rate of return. Not bad.

    While we can argue about risk, giving yourself a 9% downside cushion in the move of the stock (before you would lose any money) in case you are wrong about the direction WAG is going, is not a bad strategy.

    This guy may have had insider information, but if he really KNEW what was going to happen, he’d have bought call options. But by selling puts, it shows he was being a bit more cautious, and giving himself a cushion in case he was wrong.

    I agree that selling naked puts entails additional risk — much more than buying options. But there is a good reason to do it — selling options carries with it a much better likelihood of success. You don’t have to be right on the direction of the stock — you just have to be “not terribly wrong.”

    • Genius on October 5, 2010 at 10:05 am

      It’s not just 5%. He sold more puts after earnings for even more premium. And today, WAG just released same store sales figures which were good and so the stock is up even more. With earnings and sales figures coming out in such a short time frame, the volatility must have been high and thus he got a good price for selling the puts. That might be another reason for not buying calls. And now that the numbers are out, the vol will come down and I bet this person will exit the trade today with another nice chunk of change.

  9. Kim on October 5, 2010 at 11:02 am

    I agree that making 5% (actually a bit less) in 9 days is an excellent return. I also agree that selling options is better than buying them. However, you cannot look at the return disconnected from the risk. Ask people who wrote puts before 1987 crash. They made excellent returns for months, possibly years, but in October 1987 many accounts have been wiped out.

    The outcome of the trade has nothing to do with the fact that it was a bad trade. It is all about risk/reward. If this trader was ready to own 3.5 million of WAG shared, then it is fine, but I doubt it.

  10. L.G. on October 5, 2010 at 12:43 pm

    Based upon the actual information provided, selling a pile of O-O-$ Puts before an earnings report IS indeed a stupid strategy.

    Also the value of 0.17 / sh. was very cheap, not enough to be of much interest for typical option sellers.
    The sale of a naked O-O-$ Put option requires significant margin $, roughly 10% to 20% of the actual stock price.
    The return on margin investment must be considered.
    The risk of having to purchase the stock on an assignment of the Put must be considered.

    Without other hypothetical information about other possible hedges for this trade, the reader is left to believe that selling a pile of cheap O-O-$ Puts before an earnings report is a great strategy.
    Very misleading.
    Potentially very harmful to novice option traders.

    After the fact results are not relevant.
    This story happened to have a happy ending.
    Before the fact (earnings report)- making decisions under uncertainty is the relevant subject.
    Risk must always be considered with return on investment.

    The safest strategy in this WAG earnings report situation would be a Long conbination with both Call and Put at the same strike price close to the actual stock price and with options 6 months to go – if this trader believed that a big price move would follow the earnings report.
    This would require more $ up front to purchase the Call and the Put.
    Because of the Premium Price curves of the Put & Call vs. stock price, the winning option would increase in value more than the losing option would decrease in value after a big stock price move.
    This trade should then be closed after the impact of the earnings report is realized in 1 to 3 days to lock in the gain.

    An alternative similar strategy would be to buy both Calls and Puts which are slightly O-O-$, away from actual stock price to lower the initial investment cost, but to attain less gain from the big stock move.

    Ideally, the long Call & Put positions should be bought 2 weeks or more before the earnings report, because the option premium prices usually increase as the date of the earnings report approaches.
    More uncertainty, more volatility, higher option premiums per Black-Scholes option pricing model.
    After the earnings report and uncertainty disappears, the option premium prices usually decline

    If the earnings report has no surprises and the stock price does not move much, then the Call & Put positions should be closed quickly to minimize any losses.

    A simpler, lower risk strategy for option sellers is the Credit spread with Calls or Puts, depending upon the expected direction of the stock.
    The returns are limited, but the margin requirements are much lower than for naked short option positions.

    This WAG trader could have used a Credit Put spread to limit his risk and his margin requirements but with limited potential profit.
    Example Sell 1 WAG 29. Put for high premium price.
    Buy 1 WAG 27. Put for low premium price.
    Max. loss is [(27-29) + (Sell premium – Buy premium)]
    Max. profit is (Sell premium – Buy premium)

    He could have made the same profit with fewer option positions and with less risk.
    Presumably more than 0.17 credit per spread.

    There is nothing wrong with selling calls or puts to bring in cash, but the risks and margin investment cost and possible stock purchase cost must be considered.
    Same comment for credit spread trades.
    Most options eventually expire at zero value.

    But sometimes they explode in value with stock surprises such as buy-out offers or unique new products / technology.

    Research Qualcom stock during the last 2 years of the dot-com stock bubble before the crash.
    Make Mega-$ buying a few O-O-$ Call options.
    Also Taser stock during its big run-up before fizzling.
    Also trendy Krispy Kreme donut company stock before fizzling.

    Many years ago 1980’s ?, an option trader sold a pile of Texas Instrument Puts for 0+1/16.
    These Puts were way out of the money, so the trader thought that the 0+1/16 was a gift.
    Texas Instrument came out with an unexpected bad earnings report and the stock plunged.
    The value of the Put options jumped well above 0+1/16.
    The trader received an enormous margin call.
    The trader went bankrupt, as I recall.

    It was a big story in the business news at the time.
    Maybe it can be found in the financial news archives.

  11. Anil on October 6, 2010 at 10:05 pm

    Whatever strategy one uses , it should be with proper risk and money mangement. We should try to minimize risk and maximize profit.
    Preserving capital is the most important thing. Taking high risk and earning high is not good. Anything can happen any time in futures and options market. If Selling put, it should be sold done covered by buying atleast lower strike price. Money Management is the most important aspect of trading in futures and options. One single wrong step can lead you to bankrupt.

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