Rolling J.C. Penney Options Ahead of Expiration

Today is monthly options expiration, and trading volumes tend to build in the days (and hours) leading up to the session's close. Investors holding options have to decide whether to close their options, let them expire, or roll them to a later month.

Now is a good time to remind you of the inherent risks associated with automatic expiration. Long call options that are in-the-money at expiration – EVEN by JUST a penny or more – will automatically become that stock holding. This can be difficult for investors who a) didn't really want to own the stock or who b) don't have the money to buy the stock. And “difficult” can become “horrible” if the stock were, for example, to gap lower out of the gate on Monday. For a more in-depth look at this concept, check out George's article, Automatic Exercise, After-Hours Risk, and Other Options Expiration Issues.

We saw a nice example of what appeared to be an investor “rolling” a front-month option position on Thursday morning. In the J.C. Penney JCP option pits, we saw heavy activity at three strikes: the January 32 call, the February 30 call, and the February 27 put.

This activity all transpired while JCP was trading around the $30.60 level. So at this point, the front-month call was out-of-the-money by $1.40, the February call was near-the-money, and the February put was out-of-the-money by $3.40.

Based on factors such as trading price, trade time, and open interest, we believe an investor may have been rolling a risk reversal to a later month and to different strikes. It is apparent that the January calls (almost 10,000 of them) were bought to close for an average of 7.5 cents each and the February calls were sold to open for an average of $1.55 apiece.

It also looks as though the February 27 puts were bought to open for an average of 27 cents apiece. What we didn't see was the other side of this potential roll. It's possible that the same investor holds a long position at the January 29 put (currently with open interest of more than 21,000). With these options out-of-the-money by more than $1, they are bid at six cents, asked at eight, and maybe not worth it for the investor to sell these to close. He may be opting to let them expire worthless while rolling out the short call position. In sum, he will have twice as many long puts open through today at 4:00 p.m. Eastern.

After the January options cease to be, the trader will evidently be left short the February 30 call and long the February 27 put, which is a bearish position known as a risk reversal or a synthetic short stock. If held until expiration (instead of closed or rolled forward), maximum gains are capped at $28.28 (the put strike plus the $1.28 credit collected), in the unlikely event JCP falls to zero. Between the 27 and 30 strikes, gains are capped at this $1.28 credit. Above breakeven of $31.28, however, losses are unlimited if the stock begins to rally. It is very likely this trader has a long stock position, in which case this is a collar trade.

Photo Credit: crazytales562

The above information is provided by OptionsHouse, LLC (“OptionsHouse”) for informational and educational purposes only and is not intended as trading or investment advice or a recommendation that any particular security, transaction, or investment strategy is suitable for any specific person. You are solely responsible for your investment decisions. Commentary and opinions expressed are those of the author/speaker and not necessarily of OptionsHouse. Neither OptionsHouse nor any of its employees, officers, shareholders or affiliated companies guarantee the accuracy of or endorse the views or opinions of guest speakers or commentators. Projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature and are not guarantees of future results. Any examples used that discuss trading profits or losses may not take into account trading commissions or fees.

Share and Enjoy:

Related posts:

1. Pride International (PDE) Traders Rolling a Risk Reversal
2. Differing Views of eBay (EBAY) Ahead of Earnings
3. Calendar Spreads: Timing the Market with Options