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Unusual Options Activity: Speculation or Cheating?

Covered call writers are average retail investors looking to generate monthly cash flow in small but consistent increments and then compounding those profits. In time, it could lead to financial independence. Other investors look to make a lot of money in a short time frame by undertaking much greater risk than we do. Still others look to cash in using illegal activities. In today’s article I will ask you to draw your own conclusions.

The day is Friday July 12th and the stock is LEAP Wireless International Inc. (LEAP) which is a takeover candidate by AT&T. In the late afternoon, the share price was near $8 per share, the July $9 call option was priced @ $0.10 and the August $9 call @ $0.40. Covered call writers could generate an initial profit (ROO) of 1% and 5%, respectively. The average daily option trading volume for this company is 1320 contracts over the last 3 months. It appeared to be a normal trading day until the last hour of trading when option volume went through the roof. By days end, 7139 contracts were traded, all but 350 were calls as traders were taking a bullish stance on this stock.  I think you know what’s coming!

After market close, there was an announcement of a takeover bid by AT&T for $15 per share, almost doubling the value of the share price. That would move the calls strike price $6 in-the-money. Here is a chart of LEAP showing the gap up in share price on July 12th:

 

Unusual options activity and covered call writing

LEAP share price gap up after July 12th announcement

 

Now here is the options chart for the August $9 call options:

 

Unusual options activity and covered call writing

LEAP $9 call options gap up

 

 

According to Trade Alert, an option analytics company, there was unusual trading patterns in a 3-minute window just before market close where substantial  numbers of call options were purchased. I report, you decide.

I have been hypothesizing the past few years that the playing field for average retail investors is leveling off thanks to the hard work of the SEC and FINRA. Recently, the SEC has been investigating insider trading on Onyx Pharmaceuticals Inc. Assets and accounts have also been frozen for potential illegal trading on Smithfield Foods and Heinz Co.

So what does this all mean for Blue Collar Investors? Well that’s the good news…nothing negative for us. Had we taken a covered call position with LEAP we would have generated the call premium plus any profit up to the strike price. The time value of the $9 call would then approach zero and we could have sold the stock and used the cash to generate a second income stream or at the very least, maxed out the trade.

Conclusion:

Whether this is an example of incredibly lucky speculation or illegal trading activity is for others to determine. I will be shocked if there is no investigation and those involved are innocent until proven guilty. As I say in my books and DVDs, we look to hit singles and doubles, not grand slam homeruns. The latter can be much too risky and could ultimately get us into trouble (wink, wink).

 

My next live seminar: The Money Show San Francisco:

August 16th: 9 AM and 6 PM

To register: https://secure.moneyshow.com/msc/SFMS/registration.asp?sid=SFMS13&newReg=t&scode=032230

Market tone:

This past week’s reports did nothing to change the bullish outlook this site has for our economy and for the stock market. The strengthening housing market is a major contributing factor to our assessment:

  • Sales of existing homes were up 15.2% in June from a year ago
  • In June, there was a 5.2 month inventory of homes for sale up slightly from the 5.0 in May
  • The national median existing-home price in June was up 13.5% from a year ago @ $214,200. This represented the 16th consecutive month of year-over-year price increases
  • The national average for a 30-year fixed rate mortgage rose to 4.07% in June, up from 3.54% in May and the highest level since June, 2012. Fed Chairman Bernanke promised to9 intervene if rising mortgage rates negatively impacted the housing recovery
  • New home sales rose by 8.3% in June, the fastest pace since May, 2008 and 38% higher than a year ago
  • The median sales price of new homes came in at $249,700, up 7.4% from a year ago but 10.3% lower than 1 month ago
  • Durable goods orders ( A measure of the number of orders for a broad range of products—from computers and furniture to autos and defense aircraft—with an expected life of at least three years. Durable-goods orders are a leading indicator of industrial production and capital spending. Data fluctuate widely from month to month and are often subject to significant revision) rose by 4.2% in June much greater than the 1.2% expected by analysts

For the week, the S&P 500 was essentially flat for a year-to-date return of 20%, including dividends.

Summary:

IBD: Confirmed uptrend

BCI: Moderately bullish favoring out-of-the-money strikes 3-to-2

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)

www.thebluecollarinvestor.com

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

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6 Responses to “Unusual Options Activity: Speculation or Cheating?”

  1. barry b July 27, 2013 3:45 pm #

    Premium Members,
    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 07-26-13.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor
    Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    http://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Best,
    Barry and The BCI Team

  2. Alan Ellman July 28, 2013 6:43 am #

    New seminar:

    Yesterday, I accepted an invitation to speak @ the Orange County, California Chapter of the American Association of Individual Investors (AAII) in June. 2014. Details to follow.

    Alan

  3. Eric July 28, 2013 8:14 pm #

    Alan,

    I’ve been trading YNDX for the past 2 months from your list. I decided to hold it through earnings w/o selling the option and it worked out. Glad I didn’t. Now I can sell the 33 or 34 option depending if I go in the money or out. What criteria should determine which strike to use after an earnings report?

    Thanks for all your help.

    Eric

    • Alan Ellman July 29, 2013 7:26 am #

      Eric,

      Taking a look at the options chain prior to market open Monday morning, you can generate a 2%, 3-week return with either option. The question now is do you want some downside protection of that profit or upside potential. The answer is not the same for every trader as personal risk tolerance and market assessment plays a role. If you are selling multiple contracts you can split between both strike prices…I do that frequently mid-contract.

      Alan

  4. Alan Ellman July 29, 2013 1:04 pm #

    LGF: Earningswhsispers.com:

    Just updated the release date to 8/8 after market close…still “unconfirmed”

    Alan

  5. Alan Ellman July 31, 2013 7:19 pm #

    Premium members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

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