An investor may be expecting reduced volatility in Coca-Cola KO, as evidenced by a large options trade that crossed the tape early Thursday. In the past year, KO has traded in a range between roughly $49.50 and $65 (and is near the top of this range currently). A volatility trader may be expecting this range to narrow in the coming months and is hoping to benefit from less dramatic price action in the shares of the soft drink giant.
In early trading on Thursday, blocks of nearly 8,000 contracts traded in the January 2012 67.50 call and the 65 strike puts. The calls changed hands for $3.40 apiece and the puts for $6.10 apiece. Both traded on the bid price, suggesting they were sold. What's more, the options likely traded to open as open interest was limited at the beginning of the session.
The stock was trading at $64.85 at the time the strangle hit the tape, making the put slightly in-the-money and the call solidly out-of-the-money. The total premium collected for the 7,950 contracts sold was more than $7.5 million ($3.40 plus $6.10 times 100 times7,950). In order to keep this position hedged over the course of its life, the investor may opt to buy shares of KO if the stock rallies or short shares of the security if it declines. He would do this in order to keep this strangle open as a pure volatility play (rather than a directional one).
Although the options traded were in the January 2012 series – not expiring for 13 months – he can opt to close out of the strangle at any time. If volatility comes in over the next few months, for example, he may take profits off the table well ahead of expiration. Similarly, if volatility expands, he could close the position to cut his losses.
On the rare chance that the investor holds the strangle all the way through expiration, the maximum potential profit is the $9.50 credit collected. He keeps this entire credit at expiration if KO shares are trading between the 65 and 67.50 strikes. Below the downside breakeven mark of $55.50, losses can theoretically be as high as $55.50 (in the unlikely event that KO shares drop to zero). Above the upper breakeven level of $77, losses are potentially unlimited because of the uncovered short options. Because of this unlimited risk, short strangles (and straddles) require substantial margin and should only be attempted by advanced and experienced traders.
According to the Volatility Charting tool on OptionsHouse (part of our virtual trading platform and our regular platform), the 30-day historical volatility in KO shares has risen sharply over the past few weeks from 7.5% to just over 13%.
The implied volatility of the strangle sale is estimated to be above 18%. This volatility seller is likely hoping KO shares will move to a lower volatility.
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