By Jud Pyle, CFA, chief investment strategist for the Options News Network
shares closed down more than 3%, to $26.31, and are currently roughly 6% off their 52-week high of $28 reached earlier this month. The company is slated to release results on Wednesday after the close, and analysts are looking for the company to have earned 45 cents in its fiscal fourth quarter.
In trading today, the semiconductor industry is trading down along with the rest of the market as investors react to the impact of the Portuguese debt rating downgrade. A look at some call-buying in Xilinx suggests that an investor might be preparing for a move to the upside, or at least some volatility as a result of earnings.
Around 12:43 p.m. EST Tuesday morning, an investor purchased 30,000 May 28 calls vs. current open interest of just 1,386. The investors paid 32.5 cents for the calls when the stock was trading around $26.40. At first glance, this trade appears very bullish; it probably is. But a closer look shows that these options traded with stock, meaning the call buyer simultaneously sold shares to the option market maker.
A look at the time and sales in XLNX shows that 660,000 shares traded at $26.40 around the time of the option trade. 660,000 is roughly the number of shares that market makers would need to buy to make this trade delta neutral, meaning the hedge ratio.
The fact that the investor executed a delta-neutral trade could mean he or she is more interested in betting on volatility than direction. The 32.5-cent premium in the calls with the stock at $26.40 is an implied volatility of roughly 32%. The historical volatility for the last three months is 25%. If this investor thinks XLNX will make an unusual move on the earnings announcement, then purchasing options on an implied volatility of 32% will make money for the investor if he or she is hedged daily until expiration.
I think, however, that it is more likely that this trade is still bullish. I believe the investor has sold the stock to the option market makers to control the price jump in the stock caused by the market makers buying the stock in the open market. By doing so, the investor has managed to only purchase volatility from the market makers rather than delta. This enables the investor to get a cheaper options price because the option market makers do not have to take stock-price risk at the time of the option sale. This action allows the investor to keep the purchase of the stock more anonymous.
The investor may have bought the stock in the market prior to buying the calls, hoping that the price paid for the shares will be less than what would be implied in the option price. The investor then sells the stock to the market makers and is left with the long calls.
We will find out starting tomorrow after the close just how much of a move XLNX gets as a result of earnings.
Jud Pyle is the chief investment strategist for Options News Network and the portfolio manager of TheStreet.com Options Alerts. Click here for a free trial for Options Alerts. Mr. Pyle writes regularly about options investing for TheStreet.com.
Jud Pyle, CFA, is the chief investment strategist for Options News Network. Pyle started his career in finance in 1994 as a derivative analyst with SBC Warburg. After four years with Warburg, Pyle joined PEAK6 Investments, L.P., in 1998 as an equity options trader and as chief risk officer. A native of Minneapolis, Pyle received his bachelor's degree in economics and history from Colgate University in 1994. As a trader, Pyle traded on average over 5,000 contracts per day, and over 1.2 million contracts per year. He also built the stock group for all PEAK6 Investments, L.P. hedging, which currently trades on average over 5 million shares per day, and over 1 billion shares per year. Further, from 2004-06, he managed the trading and risk management for PEAK6 Investments L.P.'s lead market-maker operation on the former PCX exchange, which traded more than 10,000 contracts per day. Pyle is the "Mad About Options" resident expert. He is also a regular contributor to "Options Physics."