Schwartz: Tale of Two Prints

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On October 3, we posted a story titled The Tale of Two Prints. The piece highlighted two unusually large trades in two very different names: the SPDR Consumer Products Fund (XLP) and Sprint Nextel (S). While XLP has seen uninspired action since that time, shares of the phone company have been sprinting higher on news Softbank is making a substantial investment. Let's see how these to trades are playing out.

S shares are up $0.06 to $5.79 on the Softbank news Monday morning. Under the terms of the $20.1 billion deal, S will sell a 70% stake to Softbank. $12.1 billion will be distributed to shareholders and $8 billion of capital used to strengthen S's balance sheet. In addition, 55% of current S shares will be exchanged for $7.30 per share and the remaining will convert into a new publicly traded entity - New Sprint.

The big options trade in S highlighted a couple of weeks before the deal was announced was a 75000-lot of longer-dated January 2014 calls at the 7 line for $0.63 per contract when the market was $0.58 to $0.63. Another 32,000 contracts traded at the same price. The activity created 108,000 in new open interest and, at 131,691 in total open interest, the January 2014 7 call is still the second largest block of OI in the name.



At the time, S shares fetched $4.9 and a 7 call option was 43% out-of-the-money. The delta of the long-dated 2014 was 0.4. Shares now trade for $5.79 and the contract is 21% out-of-the-money with a 0.42 delta. The market has actually dropped to $0.51 at $0.61. Recall that the big block printed at $0.63 per contract when the stock was 15.4% below current levels! What happened?

While time decay was a factor, the main reason for the drop in premium is falling implied volatility, which plummeted to about 28 from 51. So, although the January 2014 7 call buyer on S is a few weeks ago seemed to place a well-timed bet on the stock, the position isn't seeing positive results because of the negative impact from time decay and, to a much greater extent, a big drop in implied volatility. In addition, the big drop in IV seems to suggest that the market was indeed "pricing in" or discounting some type of catalyst to move the stock.



Making matters much worse for this position holder is the market width for these long-term options. Note the quote on 10/2 was about $0.06 wide from bid to offer, a 10% spread in terms of option value. The quote on the latest trade is very different, $0.10 to $0.55, wide enough to drive a truck through as market makers shy away from long-term options when it is unclear what the post-deal structure will look like. This type of risk has no Greek name, but clearly is somewhat catastrophic for the position-holder.

The second big print highlighted on 10/13 is holding up a bit better. The XLP was trading around $36 at the time and saw an enormous block of 249,900 January 38 calls trade near the $0.15 offer price. Shares are up $0.03 to $35.88 today, but down about $0.12 since that time. The market on the January 38 call is still $0.12 to $0.15, from $0.15 at the time. However, open interest is 256,831 and by far the largest position in XLP options. Three months are still remaining for the trade to play out.

OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits.
At the time of publication, Henry Schwartz held no positions in the stocks or issues mentioned.

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