Option pressure. You keep reading about it. You see it in
Todd Harrison's excellent
comments. You see it in the spot-on comments by Jay Shartsis in the
Trading Track. But what does it really mean? How does it really drive stocks higher? Let's use a real-life example.
Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), which is pertinent today, given that we are all awaiting Mister Softee's earnings tonight (and there will be a live
RealMoney.com chat with some heavies here to dissect the report!).
This morning Microsoft opened around 53. It has been an up stock for the whole year. Recently, it broke through the 50 level and seems poised to go higher. However, not everyone thinks that's the case. If you were long
Gateway (GTW Quote - Cramer on GTW - Stock Picks) and you heard about slowing personal computer sales, or if you are long
Intel (INTC Quote - Cramer on INTC - Stock Picks) and you heard confirmation of the slowdown, you had to be thinking, "Hmmm, Microsoft is an accident waiting to happen. A near-term accident waiting to happen because, alas, it reports before options expiration."
After Intel, you might have decided that Microsoft could roll over after it reported. So you may have priced out the Microsoft January 55 puts
. The 55 puts are in-the-money
puts and correspond pretty closely to the downside. They traded for about $3 yesterday. Or, in English, if Microsoft got hit, you would make money, almost one-for-one, once the stock got below 51 -- if you owned that put.
If you thought the stock would get hammered, these options would be the best way to play the short. You limit your downside -- the worst you can do is lose the $3 -- but leave plenty of upside if the stock gets cracked. That's a great risk/reward ratio, and, I admit, that had I been at
Cramer Berkowitz, I probably would have taken the bait and bought them.
Now things get interesting. After the close,
IBM (IBM Quote - Cramer on IBM - Stock Picks) reports a blowout number. Then
Xilinx (XLNX Quote - Cramer on XLNX - Stock Picks) gets number cuts and doesn't go down.
Dell (DELL Quote - Cramer on DELL - Stock Picks) keeps going higher after Michael Dell's purchase. And Intel seems to be done going down (not that it is about to go higher, but it doesn't seem to want to go lower). As the market struggles to get IBM open because of the awesome demand for the name, you start thinking, "Whoa, this Microsoft, even if it is crummy, could go higher." You start thinking, "What do I do now? What recourse do I have?"
"Ahah," you mull, "if Microsoft is a blowout tonight, then maybe it can pull an IBM and gap up well beyond the 50s. Why not turn the put into an insurance play in favor of Microsoft? Why not put on the 'risk-free long?' Why not buy stock against the puts?" That way, if Microsoft is bad, you only lose the price of the put. But if it is good, you could hit the home run.
Now, thousands upon thousands of these puts have been sold and the buyers of the puts all have pretty much the same mindset. I have talked endlessly about the herd mentality. This Microsoft situation is a perfect example. These puts, which looked like a great bet on the short side, become the reason people went long. So many people did this trade today, so many people took the risk-free long, that Microsoft moved higher simply because of the puts. (I am not even including, by the way, the hundreds of funds that own the Microsoft January 50 puts and -- rather than see them go out worthless -- put them to use as a low stop against common stock. Or, in English, they buy Microsoft knowing that if the quarter is bad, they can't get hurt below 50.)
Option pressure upward, when psychology changes to the positive, as it has since last week, can be an amazingly powerful influence. Funny, right now, if I were at my old hedge fund, I would be selling some of the stock I bought at 53, trying to set the position up as a win-win either way. In other words, let's say I had a thousand Microsoft puts and I bought 100,000 common "against" it to play the upside when the stock was at 53. I would probably be taking off half the common stock position now, taking the two-and-a-half-point gain on 50,000 shares and letting the rest run, because Microsoft, by running so much in advance, might end up doing nothing or even going lower and I want to be able to play both ways. That would just be my being opportunistic. But I think others are, too. I don't think this stock will be able to crack the 56 level today, precisely because that "take half off the table" is the odds-on play, and I always played it by the book at Cramer Berk.
Random musings: All of this will be history after the close. Why not make history with us as we go online with the quarter this afternoon?! Join me and
Adam Lashinsky and
Jim Seymour on the live
RealMoney.com chat about Mister Softee's earnings.
Jim Cramer
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