Options Update: Selling Strangles on Halliburton

Following a pair of reports from the crude oil sector this morning, shares of oil services specialist Halliburton
Quote |
Chart |
News |
have whipsawed from positive to negative territory and back again in today’s trading.

The Energy Information Agency announced a 500,000 barrel rise in U.S. petroleum stockpiles this morning, prompting a sharp decline in crude oil prices and HAL shares. However, the Organization of Petroleum Exporting Countries (OPEC) said that it would cut oil output by 4.2 million barrels from September levels. The move stabilized crude prices slightly, and created additional volatility for HAL stock.

Despite the ping-pong match, options traders have flooded HAL with a slew of sold strangle positions today. Both the stock’s January 2009 20 calls and January 2009 17.50 puts have made our Intraday Volume Explosion List, with more than 7,000 options trading on both strikes. The activity immediately drew my attention due to the potential for spread or strangle positions on the shares. However, after digging into the volume, I noticed that both sides of these potential traders had been sold, creating the potential that options traders were jumping into sold strangle positions.

Halliburton option volume details

The Anatomy of a Halliburton Sold Strangle Position

As you can see from the chart above, we have several blocks of January 2009 20 calls and January 17.50 puts crossing at the bid price at the same time. For example, at 10:10 a.m. Eastern time a combined block of 3,000 calls crossed at the bid price of $0.90, while a combined block of 3,000 puts changed hands at the bid price of $1.45. The total credit for this position $705,000 — January 2009 20 call ($0.90 * 100)*3,000 = $270,000; January 2009 17.50 put ($1.45 * 100)*3,000 = $435,000; Total position: $270,000 + $435,000 = $705,000.

While a purchased strangle needs the underlying stock to move sharply in either direction, a sold strangle requires that the underlying stock remain range-bound. In today’s example, the trader keeps the entire premium collected as long as HAL closes between the 20 and 17.50 levels on expiration, which in this case, is January 16, 2009.

The maximum loss on this position is theoretically unlimited, since there is no limit to how high HAL shares can rally. Meanwhile, the trade has 2 break-even points. We calculate break even on the trade by adding the total premium received to the call strike and by subtracting the total premium from the put strike. On the upside, this point rests at $22.35 — (0.90 + 1.45) + 20 = 22.35. On the downside, this point rests at $15.15 — (0.90 + 1.45) – 17.50 = 15.15.

As mentioned above, the investor entering this trade expects HAL to go nowhere for the next several weeks, with the shares expected to remain between the 20 and 17.50 levels through expiration. I’ll take a closer look at the technical or sentiment indicators and their potential impact on this trade after the break.

Getting Technical

Technically speaking, HAL has fallen more than 51% so far this year. However, the shares have largely stabilized since early October, entering a trading range between the 16 and 20 levels. The stock’s 10-day and 20-day moving averages had provided resistance for HAL, but the duo has formed a bullish cross that could signal additional upside for the equity. Any short-term bounce for the shares could place pressure on the sold January 2009 20 call.

That said, the 20 level is home to the stock’s 180-month moving average, which could present a major technical hurdle to any potential gains for the shares. As such, the technical backdrop offers up some tentative support for the idea of a range-bound HAL, potentially benefiting a sold strangle position on the security.

Daily chart of Halliburton since October 2008 with 10-day and 20-day moving average

The Sentiment Drivers

The stock’s sentiment backdrop is not so kind toward today’s trading example, from a contrarian standpoint. Investor optimism is running rampant, as the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.80 ranks below 79% of all those taken during the past year, while 13 of the 16 analysts following the shares rate them a “buy” or better, according to Zacks.com. This bullish configuration is a problem for a strangle seller, as it runs contrary to the stock’s long-term downtrend. As such, if HAL were to fail to overtake short-term resistance, we could see this optimism unwind in the form of added selling pressure. Such a development would call into question the lower rail of the stock’s recent trading range, thus placing pressure on the sold January 17.50 put.

Sentiment indicators for Halliburton

The Verdict?

As the global economy worsens, demand for crude oil weakens, prompting a rise in stockpiles and a drop in oil prices. OPEC is attempting to put the brakes on this cycle, but with little success. However, OPEC could well be the key to success for the aforementioned sold January 2009 HAL strangle position. Falling crude prices would certainly place additional pressure on HAL shares, but OPEC’s intervention could mitigate the decline.

My biggest concern for this trading idea is the stock’s sentiment backdrop. If HAL investors lose heart and begin to abandon their positions on the shares, we could see selling pressure enter the market regardless of OPEC or crude supplies. I certainly wouldn’t jump into a HAL call at this point, and while a January 2009 20 put looks appealing given the technical and sentiment backdrops, the potential impact from OPEC makes me skittish on that front. If today’s options activity is any indication, speculators are betting that this tug-o-war will continue for the time being.

Newly revised and updated, Bernie Schaeffer’s home study program, “10 Days to Successful Options Trading,” provides a foundation for your options trading success. Includes easy-to-follow guide, CD, DVD, and a special report — Click here to learn more.

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