Friday, May 21, 2010

Mead Johnson (MJN) - Why Risk Reversals Might Trade This Summer

MJN is trading 48.59, up 2.1% today with IV30™ down 6.1%. The LIVEVOL™ Pro Summary is below.

The company has traded over 14,000 options with two hours to go on total daily average option volume of just 4,033. The largest trade (accounting for 10,000 contracts) was an Aug 45/55 risk reversal (buy puts, sell calls). The Stats Tab and Day's biggest trades snapshots are included (click either image to enlarge).

The Options Tab (click to enlarge) illustrates that both the calls and the puts have large open interest (OI), so it's not obvious at first glance if this trade is opening or closing.

The Level II pop-out for the Aug 45 puts (click to enlarge) illustrates that the OI jumped by ~3,000 in the last two days.

From what I can tell, these were purchases, meaning the purchases today are also opening. The Aug 55 calls seem to be short open interest (from what I can tell), so the trades today (the sales) are also opening. Basically I'm trying to say these trades look like a double down on open positions.

The Skew Tab snap (click to enlarge) illustrates the vols bought and sold.

Finally, the Charts Tab (6 months) is below (click to enlarge). The top portion is the stock price, the bottom is the vol (IV30™ is red, HV20™ is blue and IV60™ is yellow). The yellow shaded area at the very bottom is the IV30™ vs. the HV20™ vol difference.

Notice that the underlying actual vol (blue line) is outpacing the implied (red and yellow lines). The risk reversal trade today is bearish if not done with stock (note stock is pretty active today, so...).

This is a nice example of a trade that stays relatively vol neutral while taking a stab at a down delta move. It costs $2.88 (puts) - $1.43 (calls) = $1.45. Or in total, 100 x 5,000 x $1.45 = $725,000.

By selling the calls the trade hedges premium outlay and vega. Of course, it also risks the upside. If you feel like the market could go down, but if not, it will probably not rip up, these are good trades to examine as they hedge some risk by adding another.

Without stock this is much more bearish than a put spread purchase, but depending on the calls that are sold, can actually be premium neutral (unlike a put spread). Or in English, you might be able to take bearish positions that lose nothing if the stock stays put (unlike a put spread or put purchase). Of course, they get killed if stocks rip (also unlike a put spread or put purchase).

This is trade analysis, not a recommendation.

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