Options Update: Transocean Put Volume Spikes on S&P 500 Index Delisting

After the close on Thursday, Standard & Poor’s announced that Transocean
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was ineligible for listing on the S&P 500 Index (SPX).

The reason, says S&P, is that the company is “redomesticating to Switzerland.” RIG will be replaced by Equitable Resources on the SPX after the close of trading on December 18.

Separately, Goldman Sachs cut its price target on RIG to $58 per share from $79 per share, while Friedman Billings Ramsey downgraded the stock to “market perform” from “outperform.” Checking in with Zacks.com there is plenty of room for more analysts to follow Friedman’s lead, as 20 of the 24 brokerage firms following RIG rate the shares a “buy” or better, with no “sells” to be found.

Shifting Options Sentiment

Options traders have lagged the rest of the investing community in terms of optimism toward RIG. The stock’s current Schaeffer’s put/call open interest ratio (SOIR) of 0.65 ranks below only 40% of all those taken during the past year, indicating that the speculative group has been more optimistic toward the shares 60% of the time in the past 52 weeks. What’s more, data from the International Securities Exchange (ISE) and the Chicago Board Options Exchange (CBOE) suggests that a shift toward negativity may be gaining momentum. Specifically, RIG’s ISE/CBOE 10-day put/call ratio ranks above 80% of all those taken during the past year, indicating an increasing degree of skepticism toward RIG from the options crowd.

This trend toward RIG put options has taken an interesting twist in today’s trading, however. Looking at our Intraday Volume Explosion List, I noticed that more than 22,000 RIG puts have changed hands so far, outpacing the stock’s average daily put volume by more than 5.8 to 1. The most active contract is the December 50 put, which has seen more than 11,000 contracts trade on open interest of just 7,559. However, it was the fact that nearly all of this volume changed hands at the bid price that caught my eye today, as this potential put-selling activity runs in stark contrast to the swell in put buying reported by the ISE and the CBOE.

Transocean option volume details

The Anatomy of a Transocean Put Position

Digging into this activity, I noticed that a block of 6,000 contracts changed hands at 10:39 a.m. Eastern time at the bid price of $1.50, suggesting that the options were sold to open. Combining this data with the fact that volume far exceeds open interest at this front-month strike, it appears that we are looking at a rather large bet that RIG will hold above the 50 level by the time these options expire. Running with the put-selling theme, the total credit received for this trade arrives at $900,000 — ($1.50 * 100)*6,000 = $900,000. Remember that a put-sell trader keeps the entire premium received on the trade as long as the underlying shares remain above the sold strike through expiration, which, in this case, is December 19, 2008.

Getting Technical

Technically speaking, RIG’s recent price action offers little encouragement for put sellers. The shares have fallen more than 59% so far this year, with the shares underperforming the S&P 500 Index by 30% during the past 60 days. Furthermore, RIG is battling overhead resistance at its declining 10-day and 20-day moving averages – trendlines that the shares have closed above only a handful of sessions since late September. As these moving averages pressure RIG lower, they could force the shares to break below the 50 level, thus placing a sold December 50 put in the money.

Daily chart of Transocean since June 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

Having previously discussed the unwinding optimism among options players and the potential for downgrades from Wall Street analysts, let’s take a closer look at the short-selling community. During the most recent reporting period, the number of RIG shares sold short dropped by more than 14% to roughly 11 million shares. This accumulation of bearish bets amounts to a paltry short-interest ratio of 1.40 at the stock’s average daily trading volume, and less than 4% of RIG’s total float. The important takeaway here is that despite the increased short covering in recent weeks, the shares have failed to take advantage of the added buying pressure. Furthermore, there is little in the way of shorted shares left to provide further short-covering support, even if RIG would benefit from it.

Sentiment indicators for Transocean

The Verdict?

The facts are these: Options traders are abandoning their call positions for puts, brokerage firms are turning wary eyes to the firm amid a weakening outlook for energy prices, and a spike in short covering was unable to provide much lift for RIG. What’s more, the stock is locked in a long-term downtrend and facing resistance at its declining 10-day and 20-day moving averages. Under these circumstances, I would be more inclined to buy the December 50 put than sell it; though a less risky position might be a purchased December 60 put.

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