Beware the dreaded short squeeze in a stock; it can wreak havoc on a potential options play.
Take a look at stocks like
, a corrective vision products company, and
. They've seen their options volume spike in recent days even as a potential short squeeze looms.
Is it possible to make options plays on stocks with heavy short interest? "Of course, but it's a game for professionals," said Paul Foster with
in Chicago. "This is strictly a timing issue. Because there's no plain vanilla solution to figuring out when they could come back down."
The unpredictable nature of short squeezes, in turn, makes buying calls in these seemingly one-way-up stocks more dangerous, he added. "Everything depends on your risk tolerance."
A short-seller borrows stock, then sells it, thinking he will be able to buy it back at a lower price to replace the borrowed shares. In the case of Metricom, just for illustration, the stock was hovering under 10 at the beginning of May; on Thursday it was up 5 1/16 to 47 13/16 with no news (most recently, leading rich guy Paul Allen plunked down a big investment in Metricom, as did
It appears short-sellers had to "cover" their positions and buy shares at high prices after Metricom's recent run-up. The short interest at the end of June totaled 2 million shares.
Even worse, a scarcity of shares can force a "short squeeze," which in effect forces certain traders to buy the stock, lifting its price even further. There are only 7.6 million Metricom shares available in the public float, compared with 2 million shares short.
If a short squeeze is more responsible for a stock's rise than pure fundamentals, those calls can quickly lose their value when the squeeze has passed. On the flip side, being short calls (selling them) is dangerous because a squeeze can blow a stock right through the strike price of the options and force the seller to cover at high prices.
"If you think it's going higher, step in and buy some August 45 calls, or a straddle of August calls and puts," said one Philadelphia-based options trader. "But understand and define the risk, particularly since these options are expensive. Otherwise, short squeeze or not, you can always just buy the stock."
An August 45 straddle for Metricom, for instance, in which an investor buys an equal number of puts and calls with the same terms, would cost roughly $19 ($1,900) at current prices.
At midday today, the August 45 calls were up 1 5/8 ($162.50) to $10 7/8 ($1,087.50) and the puts were down 1/4 ($25) to 8 1/4 ($825). In part, the options aren't cheap because traders are factoring in a bloated implied volatility -- the percentage the market estimates the stock will move up or down annually -- for Metricom of 133.
MO Better Blues
Some late put trades in
didn't escape the feelers of options traders.
A 1,000-lot trade in Philip Morris July 40 puts crossed late Wednesday, just before a Florida jury found tobacco companies liable for causing disease and showing a "reckless disregard" for the health of smokers. The decision against Philip Morris and other cigarette manufacturers clears the way for the jury to return to a second phase in the trial that could award damages of more than $200 billion.
They were up from roughly 1 ($100) Wednesday to 1 5/8 ($162.50) on Thursday. "Shorting Philip Morris doesn't seem like a way to get rich, since it's a dirt-cheap blue-chip," said Kyle Rosen of
Rosen Capital Management
in Los Angeles. "In order for the stock to come down we have to see something new, and this case will be wrapped up in the courts for years."
Rosen is long both calls and stock in Philip Morris, which rose 13/16 to 38 11/16 by midday.
However, as a one-day trade, "someone probably holding the stock heard some rumblings yesterday about the trial, got in that trade as protection in case the stock came down."
Apple of Traders' Eye
Options in personal computer maker
and another laser eye-surgery concern,
, topped the most-active list.
While calls in Apple crept up in price Thursday, July 50 puts dropped 11/16 ($68.75) to 1 3/16 ($118.75) on volume of 1,008 contracts, and open interest of 313. The company's shares were trading up 2 1/2 to 52 3/8, a 52-week high.
The rise in the underlying shares may have been enough to push the puts down to a reasonable level for buyers who think Apple has topped out and want to profit from a pullback.
In Sunrise, the options traffic was unusually heavy.
From the roughly 2,300 call options in Sunrise, at a strike price and expiration of 2000 February 25, crossed at a price of 4 ($400), up 3/4 ($75), against a skinny open interest of 20 contracts.
More urgent seemed the need to buy the August 15 calls as the stock climbed 1 7/8 to 18 3/8. Those calls traded more than 1,000 contracts and rose 1 1/2 ($150) to 5 3/4 ($575).
As originally published this story contained an error. Please see
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