The broad market took it on the chin yesterday, losing around 1.5%, and Alcoa (AA) was among the worst-performing names in the Dow, shedding more than 3% of its value. The aluminum company's CEO said Tuesday that while U.S. industrial demand for the metal is improving, he doesn't feel “the current environment is such that [Alcoa] want[s] to bring capacity back” to pre-recession levels.
Some traders seem to have viewed pullback as a buying opportunity. Two large blocks traded on in-the-money, intermediate-term calls during Tuesday's session.
These blocks changed hands within 30 minutes of one another, and their similarity in size and timing suggests they may have been executed by the same trader. At 9:50 a.m. yesterday, a block of 18,930 of the January 2012 15 calls traded for $3.05, which was the ask price at the time. Then at 10:15 a.m., a block of 18,750 October 15 calls changed hands at $2.73, which was also the ask price.
Open interest at the January 15 call strike expanded slightly to more than 39,000 and open interest in October 15 calls surged from just 20 contracts yesterday to more than 20,000 this morning. This suggests the volume was trading to open during Tuesday's session.
These large options blocks traded with a short stock hedge. At 9:50, a block of 1.27 million shares traded for $16.60; at 10:15, a block of 1.31 million shares traded for $16.57. Given the corresponding delta readings for the options at the time of the trade, it seems that the trader in question shorted shares along with the calls in order to keep the trade delta neutral.
It's possible, as we often suspect, that the trader was tying the option trade with a stock hedge in order to get a quicker and potentially better-priced fill for the option trade. It is also possible that the investor already owned the shares of AA and sold out of them to replace them with long calls.
Assuming the stock hedge is closing, the risk to a long call is 100% of the premium paid. Risk is maximized at expiration if the underlying is trading at or below the strike price ($15 in this case, 7.5% below yesterday's close). Above the breakeven price, gains are theoretically unlimited if the stock rallies. Breakeven for the October 15 call trade is $17.73 (the strike plus the premium); breakeven for the January 15 call is $18.05.
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