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Tellabs Sees Delta-Neutral Action

This purchase of puts with stock could mean that the investor is more interested in betting on volatility than direction.
Author:

By Jud Pyle, CFA, chief investment strategist for the Options News Network

Shares of

Tellabs

(TLAB)

are in the red on Thursday without any recent news from the communication equipment producer, and it looks like at least one investor could be betting the downside will continue throughout the near term, judging from heavy put volume on the tape.

TLAB dropped nearly 2%, to $7.91, during afternoon trading. The company has not had any significant news since its earnings figures on April 27 (the company announced earnings of 11 cents per share, beating estimates by 2 cents). At the end of April, the company reached a 52-week high of $9.45. In July 2009, TLAB dipped to a 52-week low of under $5, and at first glance, it looks like an investor was willing to risk a hefty amount to bet that the stock could head back toward the lows during the next month.

Around 10:35 a.m. EST, 30,000 TLAB July 7-strike puts changed hands for a premium of 30 cents per contract, which was the ask price at the time of the trade. This options action suggests the investor is calling for the stock to drop at least 10% during the near term and will make money if TLAB shares are trading lower than $6.70 at July options expiration.

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If the stock is trading lower than this breakeven, the long put position turns significant but limits profits as the stock nears zero. If TLAB shares remain around their current level, maximum loss is limited to the premium paid, or 30 cents per contract.

At first glance, this trade appears very bearish; it probably is. But a closer look shows that these options traded with stock, meaning that the put buyer simultaneously bought TLAB shares.

A look at the time and sales in TLAB shows that 750,000 shares traded at $7.80 around the same time of the option trade. 750,000 is roughly the number of shares that market makers would need to sell to make this trade delta neutral.

The fact that the investor executed a delta-neutral trade could mean that he or she is more interested in betting on volatility than direction. The 30-cent premium of the puts with stock at $7.80 equates to an implied volatility of approximately 58%.

The 30-day historical volatility of the stock is roughly 58%. If this investor thinks that TLAB will become more volatile, then purchasing options on an implied volatility of 58% will make money for the investor, if he or she is hedged daily until expiration.

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."