Options Update: General Motors Puts Popular Ahead of Recovery Plan

It’s coming down to the wire for the auto industry today, as General Motors Corporation
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and Chrysler are scheduled to detail their recovery plans in Washington D.C. after the market closes.

GM has already garnered a few headlines ahead of the showdown on Capital Hill, with CEO Rick Wagoner announcing that he will discuss the automaker’s viability plans in a press conference at 6:30 p.m. Eastern. As usual, options traders are buzzing frantically ahead of the event.

Specifically, more than 29,000 GM puts have changed hands, more than quadrupling the stock’s average daily put volume and placing the security on our Intraday Volume Explosion List. More than half of this volume traded at the March 2.50 strike, with another large contingent of contracts changing hands at the March 4 put.

General Motors put volume details

The Anatomy of a General Motors Put Position

Taking a closer look at the March 2.50 puts, 4 blocks totaling 3,000 contracts crossed the tape at 10:40 a.m. Eastern time at the ask price of $0.80. Assuming that these contracts were all placed by the same trader, the total outlay for this position would be $240,000 — ($0.80 * 100)*3,000 = $240,000. Complicating matters, these trades were marked “spread.” After a little digging around, I located the other half of this spread at the March 4 put.

Mirroring the March 2.50 activity above, 4 blocks of 3,000 contracts traded on the March 4 put at 10:40 a.m. Eastern time at the bid price of $2.05. The total credit received for this trade would be $615,000 — ($2.05 * 100)*3,000 = $615,000.

Combining the debit incurred by buying the March 2.50 puts and the credit received for selling the March 4 puts nets the trader a total credit of $375,000 for the position. This figure is arrived at by adding the credit received from selling the March 4 and the debit incurred for purchasing the March 2.50 puts — $615,500 – $240,000 = $375,500.

This particular credit spread is a bit unusual in that it is in-the-money. Normally, a credit spread using puts is a neutral-to-bullish bet that allows the trader to keep the premium received as long as the stock remains above the sold (i.e. higher strike) option through expiration. In today’s example, GM is trading well below the sold March 4 put, making this credit spread a bullish position, as the trader needs the shares to rally above $4 per share before the options are exercised.

Right now, the time premium in the March 4 puts will help keep the trade from being exercised, though there is still the risk that the underlying stock could still be “put” to the trader at any point prior to expiration. It would appear that the trader is banking on a rally in GM, possibly as a result of the company’s presentation of its recovery plans later tonight.

So, by entering this trade, the investor is indicating that he expects GM to rally above $4 per share in short order so that he can keep the entire premium received. The position is in poor shape at the moment, as GM is off about 15% at last check. That said, let’s take a look at the stock’s technical and sentiment backdrops for any additional drivers for this trade.

Getting Technical

Technically speaking, GM is in poor shape. The stock has fallen more than 90% during the past 52 weeks, and is in the process of retesting its November 2008 lows near $2 per share in today’s trading. Furthermore, the stock’s declining 10-day and 20-day moving averages have steadily forced GM lower since mid-January, and key support at the 2.50 level has been broken. That said, the last time the equity broached the 2 level, GM proceeded to rally more than 81% during the following 5 trading sessions. Such a move would require the shares to blow past several levels of overhead technical resistance, including the 2.50 level and the 10-day and 20-day trendlines. But if traders are inspired, or at least not let down, by tonight’s recovery plans, we could see just such a rally.

Daily chart of General Motors since November 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

Sentiment toward GM is surprisingly optimistic among options traders. In fact, these speculative investors have been more bullishly aligned only 10% of the time in the past year, as the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 1.03 ranks below 90% of all those taken during the prior 52 weeks.

Wall Street analysts, meanwhile, are perched at the opposite extreme. Currently, all 8 brokerage firms following GM rate the shares a “hold” or worse, according to Zacks. What’s more, short sellers have followed suit, with more than 18% of the stock’s total float sold short. These naysayers could be a source of sideline money if GM shares can regain their footing.

Sentiment indicators for General Motors

The Verdict?

With the uncertainly swirling around GM and the U.S. economy, I would be loath to enter any option position on the shares at the moment. Furthermore, the position outlined above makes me a bit nervous, given the likelihood of GM shares being assigned in the event that the stock fails to reclaim $4 per share. However, I can see some of the reasoning behind it, as option premiums are heavily inflated on GM at the moment, making call buying extremely expensive. While risky, especially given GM’s current circumstances, entering an in-the-money credit spread on the stock might be a good way to take advantage of those inflated premiums.

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