Investors Sell Long-Term Calls in Procter & Gamble (NYSE:PG)

Consumer-products giant The Procter & Gamble Company PG is up about 7% year-to-date.  While nothing to sneeze at, this is below the 8% gain seen in the overall broader market. Both of these measurements are price return only, not including dividends.

Since the overall market has about a 2% dividend yield and PG has a 3% dividend yield, the total returns appear to be right in line. For the past six years or so, P & G shares have stayed within a fairly wide range, with narrow movement below 50 or above 70. Judging by some of today's options activity, it appears that investors are assuming this limited volatility will continue through the next 12 to 14 months.

Roughly an hour into the trading day, a block of 10,000 PG January 2012 70-strike calls traded for $2.03 per contract. This was the bid price at the time so indicates the options were opened on the sell side of the trade.  In exchange for selling these long-term upside calls, the investor collected $2.03 million in premium.

This short option was tied to the purchase of stock – 330,000 shares of stock, to be specific. The investor appears to have paid $64.89 per share ($21.4 million in total) to open this delta neutral position. Because the delta risk is lowered, changes in the price of the stock itself will not have a pronounced impact on the trade. For every tick higher in PG shares, gains in the long stock should theoretically be offset by losses in the short call.

What will impact this trade is a change in implied volatility. The position is negative vega so declining volatility will positively impact the overall value of the two-legged position.  A one-point move in implied volatility will theoretically impact the option price 24.8 cents.  The total short vega from this block trade is $248,000 for each vol point.

If volatility declines in PG and the stock subsequently tightens its trading range, the chance for profitability increases. The option price indicated about a 15.8% implied volatility, compared to 30-day historical volatility of 9.3%. Today's trader is likely expecting implied vol to possibly decrease, enabling this substantial trade to profit before expiration. If the position does not move in the trader's favor, theoretical losses are significant in either direction and unlimited to the upside.

If held until expiration, the delta-hedge ratio will change and it is expected the short call trader will adjust his stock position appropriately.  To learn more about dynamic delta hedging and other techniques used by professional and institutional option traders, be sure to attend tomorrow's Two Traders, One Strategy webinar at 4:30 ET.

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