A Spread Trade in Cerner Options

Why would an investor do this? Well, for one thing, if the investor is wrong, he does not start to lose at expiration on the downside until $33.225. That cushion might be attractive to the investor. A second reason that the investor might have sold shares is because by selling the option market makers their hedge, the investor does not absorb the market impact of the market makers rushing to buy their hedge.

The market makers are going to be inclined to buy their stock as soon as possible, and because CERN typically trades only 1.2 million shares a day, if the investor had not sold the 700,000 shares at the same time, the cost for the spread may have been much higher.

A look at the difference in implied volatility in the calls and the puts shows us how a bullish investor can take advantage of skew in CERN. Skew is a term that describes the difference in out-of-the-money puts vs. out-of-the-money calls. In this case, the implied volatility of the June 32.50 puts was 54, while the implied volatility of the June 42.50 calls was 43.

So the investor bought volatility on a 43, and sold on a 54. Why do the market makers let the investor do this? Because of supply and demand for options. Typically, market makers have to sell out-of-the-money puts and buy out-of-the-money calls from others. So this investor in CERN is taking advantage of that, and supplying some of the demand.