Guess the Leveraged Strategy in This Tech Darling: Options Recap

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Will a high-flying tech disruptor hit $95 next month? One big investor seems to think so.

Call volume spiked in PayPal (PYPL) yesterday as an options trader went long at one level and sold twice as many contracts at a higher strike. It looks like they already own the stock and hope to squeeze even more profits out of a quick sprint to new highs.

Here’s how it looked:

  • A block of 10,000 September 90 calls was bought for $1.67 near the end of lunch hour.
  • At exactly the same minute, 20,000 September 95 calls were sold for $0.45.

If you knew this strategy is called a “ratio spread,” then take a gold star. If you didn’t know, here’s how it works:

  • The investor has the right to buy 1 million PYPL shares for $90 because he or she owns 10,000 calls at that strike.
  • They must deliver 2 million shares for $95 if they’re over that level on expiration. Therefore, they probably already had at least 1 million shares that got tied into the trade. (See our Knowledge Center for more on the risks of naked call selling.)
  • They paid a net $0.77 for the ratio spread, which could expand to $5 value if PYPL reaches $95. That would represent a profit of more than 500 percent — on top of the money he or she would earn on their shares.

What’s the cost of that extra juice? Less profit from a really big rally. Say the shares spike to $100 or $110. They’d still be forced out at $95. The investor also remains exposed to possible downside risk.

PYPL rose 0.85 percent to $87.75 and is up 46 percent in the last year. It fell on a weak earnings forecast on July 25, even though profit and revenue beat estimates.

Overall options volume in the company was slightly above average yesterday, with calls outnumbering puts by a bullish 10-to-1 ratio.

PayPal (PYPL) chart with moving averages.
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David Russell is VP of Content Strategy at TradeStation. Drawing on nearly two decades of experience as a financial journalist and analyst, his background includes equities, emerging markets, fixed-income and derivatives. He previously worked at Bloomberg News, CNBC and E*TRADE Financial. Russell systematically reviews countless global financial headlines and indicators in search of broad tradable trends that present opportunities repeatedly over time. Customers can expect him to keep them appraised of sector leadership, relative strength and the big stories – especially those overlooked by other commentators. He’s also a big fan of generating leverage with options to limit capital at risk.