Options Update: Broadcom Draws Bullish Credit Spread Attention

The patent fight between Broadcom and Qualcomm
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took another turn yesterday. After the close last night, the International Trade Commission (ITC) rescinded its limited exclusion order barring some Qualcomm chips from the U.S. The decision sends the case back to the ITC’s administrative law judge. However, despite the seemingly negative twist of fate for BRCM, the shares have surged more than 6% in today’s trading.

Whether because of this news, or the company’s looming quarterly earnings report on Jan. 29, BRCM has been targeted by some heavy put activity so far today. In fact, puts have outpaced their daily average by more than 9 to 1, placing the security on our Intraday Volume Explosion List. Approximately 20,000 puts have changed hands on the security, but it was the sizable block trades on the March 17 and March 15 puts that caught my attention this afternoon.

The Anatomy of a Broadcom Bull Put Credit Spread

Digging into the activity, I discovered that 2 large blocks of 7,500 contracts traded on both the March 15 put (RCQ OC) and the March 17 put (RCQ OQ) at about 10:23 a.m. Eastern time. The RCQ OQ contracts changed hands at the bid price of $1.65, while the RCQ OC contracts traded at the ask price of $0.85. With the blocks trading at the same time on the same exchange, I can reasonably assume that these trades are related. In fact, it would appear that we are looking at a neutral-to-bullish credit spread on BRCM.

Broadcom put volume details

A bullish credit spread involves selling a higher-strike put and purchasing a lower-strike put. This results in a net credit to the investor’s account. The maximum profit is achieved as long as the sold put stays out of the money by expiration. In today’s example, the trader needs BRCM to stay above the 17 level by the close of trading on Feb. 20, when these options expire.

So, how does today’s example work on paper? First, the trader purchases the RCQ OC puts for a debit of $637,500 — ($0.85 * 100)*7,500 = $637,500. Next, the trader sells the RCQ OQ puts for a credit of $1,237,500 — ($1.65 * 100)*7,500 = $1,237,000. A total credit of $600,000 for the position is arrived at by adding the credit received from selling the March 17 and the debit incurred for purchasing the March 15 puts — $1,237,500 – $637,500 = $600,000.

Hedging Your Bets

So, why not just sell the March 17 puts outright and collect the entire premium? Well, the purchased March 15 puts act as a form of insurance against an unexpected plunge in the position. Once BRCM breaches the 17 level, the sold 17 put becomes a liability, and continues to lose money until the shares breach the purchased 15 put.

By entering this trade, the investor is indicating that he expects BRCM to hold above the 17 level for the next several weeks. The shares have rallied approximately 6% today, and are holding their ground about the 17 level so far. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

From a technical perspective, BRCM has seen better days. The stock is off more than 26% in the past 52 weeks, but compared to the S&P 500 Index’s (SPX) loss of 38% in the same time frame, BRCM appears to be an outperformer. In fact, the shares have bested the SPX by more than 4% during the past 20 trading days on a relative-strength basis. The equity has rebounded nicely from its November lows near $13 per share, and even reclaimed its 10-week and 20-week moving averages – both currently located just below the 17 level. These trendlines are now on the verge of a bullish cross, a development that could provide support for the shares.

The caveat, however, is staunch overhead resistance in the 18-19 area. BRCM has not closed a week above the 18 level since late September, while intraday treks above this area have met with rebuffs in the 19 region. These technical hurdles could be of consequence to a bullish call trader, but for the bull put spread mentioned above, BRCM only needs to hold above the 17 level. As such, a sideways trend between potential buying support at $17 and overhead selling resistance at $19 shouldn’t impact today’s trading example.

Weekly chart of Broadcom since March 2008 with 10-week and 20-week moving averages

The Sentiment Drivers

Investor opinion toward BRCM is weighted to the bearish end of the spectrum – a development that could provide support for the shares. Specifically, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.82 ranks above 73% of all those taken during the past year – hinting at pessimism from the options crowd. Meanwhile, 13 of the 25 analysts following BRCM rate the shares a “hold” or worse. This configuration leaves the door open for potential upgrades from the brokerage bunch, which could prove beneficial to a bull-put credit spread.

Sentiment indicators for Broadcom

The Verdict?

During the past 7 trading sessions, the SPX has traded in a 30-point range on an intraday basis. Can you say volatility? Sure you can. These types of broad-market swings might push option premiums higher, thus making premium selling quite attractive, but they also increase the chances of your position moving quickly, and drastically, against you. While selling the March 17 put nets you a nice profit, the stock could just as quickly plummet to the 15 level or below on a negative reaction to earnings or any other number of market/economic factors. As such, the purchased March 15 put on the bull-put credit spread is a much needed insurance against such developments. Without it, selling the March 17 put alone is a dangerous play.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.