Pride International (PDE) Traders Rolling a Risk Reversal

Offshore drilling contractor Pride International, Inc. PDE has been consolidating north of the 30 level for the past six weeks or so, following a sharp uptrend in September and October. Based on some unusual options activity we saw Thursday midday, it looks as though a large-scale investor is hedging his or her portfolio against short-term downside in the shares.

A four-legged trade transpired shortly before noon eastern time. Essentially, a synthetic short stock position was rolled from the front month (December) series to January.  Blocks of roughly 10,400 traded at the below strikes and appear to have been executed as follows:

• December 27 puts: 10,400 sold for $0.05.
• December 30 calls: 10,400 bought for $1.175
• January 27.50 puts: 10,400 bought for $0.40
• January 30 calls: 10,400 sold for $2.05
• Net credit for this spread: 52.5 cents, or $546,000 for the lot of 10,400.

Volume at the December strikes was less than open interest while volume at the January strikes was considerably more than open interest.  This suggests that an existing synthetic short stock (long put, short call) was closed and while the later-dated spread was opened, effectively “rolling” the position from the front month ahead of expiration on Friday.

With the December options off the books as of Friday afternoon, this becomes a synthetic short stock (also known as a risk reversal) traded for a net credit of $1.65.  As a two-legged spread (without any long or short stock involved), this position has a net negative delta of nearly 80% and will gain in value as the stock declines and lose value if the stock increases.

At expiration, the position will be worth the net credit of $1.65 if PDE is trading between the 27.50 and 30 strikes.  Below the 27.50 strike, gains begin to appreciate and are limited only by the zero floor.  Above the upper breakeven price of $31.65 (the call strike plus the credit), potential losses are unlimited as the stock rallies. The illustration below, created with our profit/loss calculator tool, demonstrates how this short synthetic looks when the January options expire.

If the investor was long PDE shares at $31.16 (as a hypothetical example), this turns into a collar trade, where the put is a married put and the short call is a covered call. The profit/loss profile of this trade is similar to a bull spread, with gains capped at the higher strike price and losses limited at the lower strike price.

We have no way of knowing if or when the investor was long PDE stock but the calculations would be as follows: breakeven is the stock price ($31.16) minus the premium collected for the spread ($1.65), or $29.51. Maximum gains above 30 are $0.49, or the premium collected for the January spread less the difference between the stock and the 30 strike ($1.16).  Maximum loss is $2.01, or the difference between the stock and the put strike ($3.66) less the premium.

Photo Credit: amanderson2

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