Using Friday's Options Activity To Get Ready For Monday's Market

by: SA Editor Rocco Pendola
In addition to my own scans and watch lists, I use three main sources to follow options-related news: Daily Seeking Alpha columns by Frederic Ruffy, Interactive Brokers and optionMONSTER.
While I get great use out of these sources and have even made money thanks to them, you have to be careful not to chase the stocks or options they mention. Occasionally, you can find examples to capitalize on. Below I detail options brought to my attention by these sources and how investors might consider playing them - or the underlying security - if at all, during the trading week.
My attention spans most of Friday's trading day, including early in the session, so some information may change. As with all of my articles, use my suggestions and analysis as the impetus for future research.
Apple (NASDAQ:AAPL): For some reason, I received some flack for buying 3 AAPL January 2012 $400 calls at $35.55 on Thursday. A few comments to Thursday's $10,000 portfolio update indicated it was a bad trade. I closed the position in the final hour of trading Friday at $37.70 for a $645 gain. That brings the all-cash balance in the $10,000 portfolio I seek to double by the end of the year to $17,502.
I would hate to see what type of gain I could have thrown together in the span of 24 hours if the trade was actually worthy of respect.
Anyhow, based on the response I receive to these Friday options columns, a fair number of people who read them have recently introduced themselves to options. To them, I say, don't get sidetracked by the know-it-alls who chime in on the comments section of the articles. While nine times out of 10, the people who make options-related comments provide useful information, a few like to show how much they know. This tends to not only hinder the process of learning, but insert unneeded noise into the trading process.
The AAPL options trade I pulled off is about as straightforward as they come. Have a look at the charts from an article I wrote on September 6th. They show the performance of several stocks, including AAPL, after the recent market routs. My option trade aimed to play this history of AAPL bouncing back nicely after triple-digit drops in the DOW. I got what I expected - a repeat of history.
Short of buying the stock outright, which requires a lot more equity than I have in the $10,000 portfolio, the way I played it achieved my goal of seizing the anticipated rebound as well as, if not better than, any other strategy available. To get into issues of time decay and such only - needlessly - complicates matters.
In situations like this, pick an around-the-money strike and a expiration month that's at least 2-3 months out. And, very simply, if the underlying stock goes up you win quick; if it goes down, you lose in the near-term. But you give yourself breathing room to wait around for the expected post-swoon recovery. By using a stop loss, you cap your risk on the trade, as you would with any other. It's that simple.
Liberty Media (LINTA): optionMONSTER highlighted bullish put selling activity in LINTA options on Friday:

optionMONSTER's systems have detected a single trade of 6,500 November 16 puts that went for $1.05, the bid price on a wide spread, indicating that they were sold. There was no open interest at the strike previously, so this is clearly a new opening position.

LINTA trades at $16.13, flat on the day. Shares of the company, which owns stakes in businesses such as QVC and Evite, have been on the rise since hitting a 52-week low of $12.44 in early August. They did climb as high as $17.50 on Wednesday, their highest level since mid-July.

The put selling is a bet that the stock will remain above the strike price through expiration. The seller then keeps the credit as profit. If the stock is below the strike, the seller then faces the obligation to buy the stock if the position has not been closed beforehand.

As optionMONSTER noted, the 6,500 contract trade alone accounts for 100% of the volume and open interest in LINTA November $16 puts. Looking across all other LINTA calls and puts, only 138 contracts changed hands.

If you're getting into trading options, be sure to look deeper before acting on reports such as the one above from optionMONSTER. The put sale pulled off represents the work of one trader (or firm). And while it's a relatively bullish move, it does not indicate broad bullish sentiment in the LINTA options market. Often options activity can reflect broad market mood on an underlying stock; in this case, it simply does not.

Of course, Liberty's court victory against BNY Mellon earlier in the week likely provided the impetus for the optimistic trade. It's the same news that caused Sirius XM (NASDAQ:SIRI) to rise and subsequently fall earlier in the week. Chasing a news blurb and a sudden, unfounded volume spike sometimes works for day traders, but, often, it turns investors with longer time horizons into bagholders.

Speaking of SIRI, relatively strong volume and noticeably large open interest persists in out-of-the-money January 2012 call options. As I noted in previous Friday options articles, a good chunk of this activity appears to be covered call writing, indicating the expectation of limited upside in SIRI shares. In other words, the January $2 calls, with the largest open interest of all SIRI calls at 224,922, indicates call writers do not believe SIRI will come anywhere near its 52-week high of $2.44, let alone head north of the $2 mark between now and expiration.

Bank of America (NYSE:BAC): Ruffy spotlighted an interesting - and bearish - options trade in BAC on Friday:

The top equity options trade so far today is in BofA (BAC). After touching $6 even and closing at a new 52-week low of $6.06 Thursday, shares are up 23 cents to $6.29 Friday. In options action, a 40,000-contract block of Feb 3 puts was bought on the bank at 24 cents per contract. It was part of a 1X2. The strategist also sold 20,000 Feb 9 puts at $3.03. The spread possibly rolls a bearish position or hedge down in strikes. Feb 9 puts on BofA saw opening activity on May 23-24 when the stock was near $11.50 and 82.5% above current levels. At that time, the contract traded at 38 cents.

I think this trade reflects a strategy similar to the one I suggested investors could use if they had banked considerable profits, long or short, in Netflix (NASDAQ:NFLX):

In any event, if you have at least a few thousand dollars worth of profit from a NFLX trade - long, short or otherwise - I think it's wise to make a relatively small wager on a full-scale implosion. What Len Brecken "said" on Seeking Alpha months ago, all of a sudden, does not sound so crazy.

In the BAC example, it looks like one trader took roughly $5.3 million in profits from BAC February $9 puts and rolled about $960,000 of them into what one could call a lottery ticket - BAC February $3 puts. While I could easily see the $3 put trade becoming another wildly profitable one, let's just call it a long shot for the sake of argument. From that perspective, this move represents playing with the house's money, but sticking with the sentiment that full-scale implosion has a reasonable chance of taking place.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.