Options Update: General Electric Targeted by a Bullish Credit Spread
NBC supposedly scored a coup when it secured broadcast rights to the 2008 Olympics in Beijing, China. The broadcast arm of Dow Jones Industrial Average (DJIA) conglomerate General Electric
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PowerRating) success with its online broadcast of the March Madness tournament – which brought in some $23 million in online ad revenue. However, NBC has only made about $6 million in online video ad revenue according to eMarketer.
The company’s missteps in handling the online broadcast of the Olympics have garnered quite a bit of negative attention in the financial media and on Wall Street. But options players have also taken note of the equity, which brings us to today’ unusual options activity on NBC parent company GE. More than 49,000 puts have traded on blue-chip conglomerate so far today, more than quadrupling GE’s average daily put volume and placing the stock on our Intraday Volume Explosion List. What caught my eye today, however, was the 16,607 puts that changed hands on GE’s September 24 put and the 21,457 puts crossed the tape on the stock’s September 26 put.
Anatomy of a Credit Spread
Digging into the activity, I discovered that 2 large blocks of 15,058 contracts traded on both the September 24 put (GEW UX) and the September 26 put (GEW UZ) at about 10:16 a.m. Eastern time on the American Exchange (AMEX). The GEW UX contracts changed hands at the ask price of $0.08, while the GEW UZ contracts traded at the bid price of $0.21. 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 GE.
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 hypothetical trader needs GE to stay above the 26 level by the close of trading on September 19, when these options expire.
So, how does today’s example work on paper? First, the trader purchases the GEW UX puts for a debit of $120,464 — ($0.08*100)*15,058 = $120,464. Next, the trader sells the GEW UZ puts for a credit of $316,218 — ($0.21*100)*15,058 = $316,218. A total credit of $195,754 for the position is arrived at by adding the credit received from selling the September 26 puts ($316,218) and the debit incurred for purchasing the September 24 puts (-$120,464) — $316,218 – $120,464 = $195,754.
Hedging Your Bets
So, why not just sell the September 26 puts outright and collect the entire $316,218 premium? Well, the purchased September 24 puts act as a form of insurance against an unexpected plunge in the position. Once GE breaches the 26 level, the sold 26 put is now a liability, and continues to lose money until the shares breach the purchased 24 put. The maximum loss at this point is limited to the difference between the 2 strikes, or $3,011,600 for this position — (2.00 * 100)*15,058 = $3,011,600.
Minus the purchased 24 put, losses increase for every additional point in the money the sold 26 put gains. For example, if GE falls to $23 per share, losses on the sold 26 put balloon to $4,517,400 — (3.00 * 100)*15,058 = $4,517,400. However with the purchased 24 put now 1 point in the money, it off sets the additional loss in the sold 26 put, limiting the total loss to the maximum $3,011,600.
So, by entering this position our hypothetical trader needs GE to hold above the 26 level by the close of trading on September 19. Let’s see if the stock’s technical picture or sentiment backdrop offer up any clues on the potential for the shares to hold their ground…
Technically Speaking
From a technical perspective, there are a couple factors that could help keep the September 26 put out of the money and allow the hypothetical trader to keep his entire premium. First, GE has growing short-term support at the 28 level – a region that has provided a backstop for the shares since mid-July. Second, GE has only closed a handful of months below the 26 level since breaching this region in March 1998. This level helped buoy the shares in June and July, and should continue to provide this supportive backdrop for GE throughout September. Finally, the stock’s 200-month moving average has ascended into the region, and is currently perched in the 27 region.
The Sentiment Drivers
Meanwhile, GE’s sentiment backdrop offers up few possibilities for support. Short interest is a paltry 0.7% of the stock’s total float, while analysts are split with 6 “buys” and 6 “holds.” However, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 1.24 ranks above 98% of all those taken during the past year, indicating that speculative investors have been more pessimistic only 2% of the time in the prior 52 weeks. If NBC’s Olympic situation turns out better than the headlines are predicting, we could see this negativity evaporate, potentially leading to buying pressure for GE. Meanwhile, heavy put open interest resides at the 27.50 level, potentially providing options-related support for the shares as September option expiration nears.
The Verdict?
A bullish credit spread position on GE looks pretty solid from a purely technical standpoint, with short-term support at the 28 level, and long-term support from the stock’s 200-month moving average. There is a bit of optimism from analysts that could prove troublesome if Wall Street decides to issue a round of downgrades. Still, the 26 level itself is a long-term support level, and could ultimately keep the sold September 26 put out of the money. As long as it doesn’t come to a showdown at the 26 level in the week of September 19, today’s hypothetical trader should be sitting pretty with this credit-spread position.
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