Large-Scale Put Sale in Walgreen Company (NYSE:WAG)

It appears that an institutional options trader  has placed a limited-bullish bet on shares of Walgreen Company WAG today. The trading weapon of choice is front-month, out-of-the-money puts. The October 27 put has seen 35,000 contracts change hands today, compared to open interest of just 1,252. Based on this disparity,  most likely these options are trading to open.

At roughly 10:50 a.m. Eastern Time, one block of 34,300 puts traded at the mid price of 17 cents per contract. If these puts were sold, as our data suggests, this amounts to $583,100 in premium collected (the per-contract price times 100 times 34,300).

Put sellers typically utilize out-of-the-money puts and profit if the underlying stock stays above the chosen strike price, leaving the  obligation to buy the stock at a lower price worthless at expiration. If WAG is still trading north of $27 when the options expire in 25 days, the investor keeps the premium collected as profit. If held through expiration, he doesn't even need to pay exit commissions as the puts will expire worthless.

WAG is currently trading at $29.23 so it would need to fall 7.6% before these puts are in-the-money.  Selling out-of-the-money puts is not a screamingly bullish strategy. . The stock doesn't need to move higher for the put seller to profit; it simply needs to hold in place or move only slightly lower, depending on the location of the strike price.

If WAG does regress below 27 ahead of October expiration, the investor will most likely be assigned and obligated to buy WAG shares at an effective purchase price of $26.83 (strike price minus premium collected).  Here's where the numbers get really impressive. The cash outlay required to cover these 34,300 puts is more than $92 million.  Remember that 34,300 puts represents 3.43 million WAG shares at $26.83 a pop.

At expiration below the breakeven price of $26.83, losses accrue as the put seller is exposed to any declines in the stock.  While technically capped at zero in the stock, losses can be as much as the $92 million level – quite a difference from the maximum potential profit of $583,100.  Of course, a put seller can choose to exit his position long before expiration if the underlying begins to move against him.

To visualize the risk at expiration, I've used a profit/loss calculator courtesy of my virtual trading account (sign up for your own here). You can see that profits peak above the 27 strike and losses begin to accelerate below the breakeven level of $26.83.

WAG) short put" src="http://oh-image.s3.amazonaws.com/September/100920WAG.jpg" border="0" alt="Profit and Loss of Walgreen (WAG) short put" width="531" height="322" />

Photo Credit: Fristle

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