Wednesday Options Update: MCD, CAT, MGM & IYR

McDonald’s Corp. (MCD) – More volatility selling was the theme at the home of the world’s biggest restaurant chain. We noted a similar strategy earlier this week following some decent earnings results. Shares today are 1% lower at $58.45 but well above the 52-week low of $44.29. Since the time when shares reached $61.00 last week, option implied volatility has slipped 4% to 24%, which makes it a very stable stock in this environment and lower than the broader market fear gauge – the VIX, which reads 28.78 today. A writer of option premium sold 10,000 put options in the December contract at the 52.50 strike for a premium of 2.40. Shares in MCD have closed beneath this strike price on 13 occasions in 2009 and if delivered by expiration the seller is buying a Big Mac here at a share price of $50.10 courtesy of the juicy premium received by way of compensation for agreeing to take delivery of the stock. Considering option open interest at this strike is less than 2,000 we’re guessing that this is the activity of an option investor bullish on the prospects for the company.

Caterpillar, Inc. (CAT) – The continued contraction of some of the world’s largest economies has widened the U.S. trade deficit for the month of April and pushed exports to the lowest level in approximately three years. The shrinkage in exports reflects the decline in foreign demand for engines, machinery, and metals, driving shares of the machinery giant lower by nearly 2% to $37.49 today. Options activity on CAT revealed that some investors wouldn’t bet their lives on a significant recovery in the price of the stock through expiration in November. Thus, sold strangles were initiated through the sale of 2,000 puts at the November 35 strike price for a rich, in-the-money premium of 3.63 apiece, while an additional 2,000 calls were also sold at the November 45 strike for 2.18 per contract. The gross premium amassed on the transaction amounts to 5.81 and will be retained in full if shares of the underlying remain strangled between the two strike prices described above. The parameters of the trade provide ample leeway for the price of CAT to fluctuate over the next six months. However, we note that losses would accrue on the strangle in the event that shares swing higher than the breakeven point to the upside at $50.81 or fall below the breakeven point to the downside at $29.19 by expiration. One other noteworthy transaction occurred at the November 25 strike price where an investor took profits today by closing out a short position. He originally sold 8,000 puts for an approximate premium of 1.70 per contract on April 30, 2009. Today he realized profits of about 72 cents each by buying back the puts for an average premium of 98 cents. Investors involved in both trades described were likely taking advantage of the lower volatility reading of 46% on CAT today, down from 51% at the start of the week.

MGM Mirage (MGM) – Shares of casino-operator, MGM are down 1.3% today at $7.05 while an option investor has taken on board premium of $700,000 after the sale of 20,000 put options expiring in July at the 6.0 strike. The trade appears to be the work of an investor relatively bullish on the outlook for the gaming and hotel sector or the work of a volatility bear in the expectation that option premium will decline as recovery expectations grow. In either case, a naked put sale here would require a commitment from the seller to take delivery of the shares should a put buyer wish to exercise his selling rights ahead of July’s expiration. In taking on board that possibility the put writer is compensated by a 35 cent premium today, which would effectively lower the entry price on buying shares of MGM to $5.65. Implied volatility is creeping lower on theses options today and has once again broken the 100% barrier as markets calm. The fair-value of these puts at the time they were recorded this morning was 39 cents with implied volatility at 100%. To put declining volatility in perspective, a 10% drop in its reading to 91% over the course of the next week would theoretically reduce the put premium to 27 cents or 30% lower than fair value today.

iShares Dow Jones U.S. Real Estate Index ETF (IYR) – Options activity observed in the July contract this afternoon may indicate some nearer-term bullish sentiment on the real estate ETF. Shares of the underlying fund are off by more than 2% to stand at $34.27. Traders appear to be taking advantage of richer put premiums on today’s decline by selling 3,000 puts at the July 30 strike price for 60 cents each as well as selling another 3,000 lots at the just out-of-the-money July 34 strike for 1.90 per contract. Put-shedding in isolation is generally a bullish signal, but we also noticed some 3,000 calls traded to the middle of the market at the July 38 strike price for a premium of 65 cents. Further, an additional chunk of 3,000 calls were purchased at the July 40 strike price for 33 cents apiece. The call options traded may or may not be the work of an IYR-bull. Plain vanilla call buying would suggest a potential near-term rally in the ETF, but the transactions could also represent the work of a bearish investor utilizing the premium proceeds from the sale of these options to fund put purchases.