One day after news that it won a $3.1 billion Air Force contract for IT support and a $16.5 million delivery order from the U.S. Army to expand the technology infrastructure at Fort Meade, shares in defense contractor General Dynamics (GD - commentary - Cramer's Take) are trading 1% lower at $82.92. In keeping with the tepid response among traders, the fourfold increase in option trading volume ahead of the noon hour was found not in directional trades, but in long collar activity in the November contract. Here it seems that a trader bought November 80-strike puts at $4.30, funding part of the purchase with the sale of 95-strike calls for $1.60.
All else being equal, this is an indicator of bullish sentiment because the trader likes General Dynamic stock enough to hold it long -- but he's nervous enough to protect the position from downside erosion by buying a protective put, and the short call at the other end of the collar essentially functions as a covered call at which he must relinquish his stock position if shares break higher. General Dynamics shares have traded as high as $94.78 over the past 52 weeks (a level reached in December), making that price level not at all out of reach.
General Dynamics isn't the only defense sector play trading on extraordinary volume this afternoon. Shares in Raytheon (RTN - commentary - Cramer's Take) are up 2.3% to $57.61 on 5.7 times the normal level of option trading volume, firmly situated in out-of-the-money calls at the November 65 strike. These are trading on volume nearly triple the open interest at $1.05 a contract and may represent covered-call writers or buyers betting on 15% upside for Raytheon shares by November. The $65 level is not unknown territory for this stock -- it has traded at that level as recently as May.
Finally, an update on option activity in General Electric (GE - commentary - Cramer's Take), which we've been watching for the past few weeks since heavy put-trading activity and an unusual drift higher in implied volatility seemed to precipitate an analyst downgrade and concerns that the conglomerate might seek outside capital. Shares are down 0.60% to $26.53, and while implied volatility remains more or less around those mid-June highs, ticking in at 34.5% against 25.9% historic volatility, a cluster of volume in September puts that looked to us like spread activity would suggest that some traders are putting a target to the maximum downside.
It appears that about 18,000 lots traded in a spread between the September 26 and 29 strikes, with a trader buying the higher strike at $2.99 against the sale of the lower strike at $1.29. The resulting $1.70 debit breaks even for the trader at $27.71, and is best deployed with shares trading between $26 and $27.71. Ideally, the trader wants the spread between the options to widen, something that is likely to happen with a decline in share prices. But note that the sale of the lower strike -- on which the trader may be exercised -- puts an implicit limit on the downside in GE, and with the company already having logged its 52-week low at $26.16, the view implied by a long put spread at these strikes is that the company won't face a significant drop below those levels heading into September.
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