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AOL Turnaround Story

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AOL (AOL) shares are up 2.68% to $34.89 on positive commentary Friday night from Mad Money's Jim Cramer. The internet company has struggled in recent years amid competition from larger Internet companies like Yahoo! (YHOO) and Google (GOOG), and while many 'new economy' shares are at all time highs, AOL is 4.5% below the levels seen a year ago. Yet, while the stock has lagged, Cramer suggests that investors look AOL as a turnaround story and one big player in options market seems to agree.

After pouring over the data, Cramer is convinced that AOL is very well-positioned to once again dominate the Internet. While Wall Street has written off the stock for years, AOL now runs many popular web sites like Daily Finance, TechCrunch, and Huffington Post. In addition, the company is now well-positioned to capitalize on the next big thing: i.e. television-like programming available only on the web. It already owns a network called AOL On.

Cramer concludes, "I think AOL is a bargain right now trading at 18.3X next year's earnings estimates. And with management putting their money where their mouth is I think you should be in there buying with them."

One player in the options market seems to concur and opened a hefty three-way options spread in AOL on Friday, selling 10,000 April 28 puts on AOL at $1.40, buying 10,000 April 40 calls for $1.40 and selling 10,000 April 46 calls at $0.475. In other words, Apr 28 puts were sold to buy Apr 40 - 46 call spreads, at $0.475 (credit) on the three-way. The hefty position, involving a total of 30,000 contracts, nearly doubled the total open interest in the options on AOL.

The options volume spike in AOL Friday is interesting because it seems to be expressing a bullish view on shares through the first few months of 2014. Writing the 28 strike puts is expressing willingness from the investor to buy shares at that price (assigned on the puts), if the stock trades below that level through mid-April. The 40-46 provides upside exposure should shares rally beyond $40 through the expiration. If the stock holds below $28 and $40, and the position is left open through the expiration, all of those options expire worthless and the investor pockets the $0.475 credit. Therefore, the only risk is on a move below the breakeven of $27.525. The company's next test: Earnings due out around November 6.

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At the time of publication, Henry Schwartz held no positions in the stocks or issues mentioned.

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