Let's Play With Unusual Option Activity

The options market offers incredible leverage for those truly in the know about future stock price action. The Securities and Exchange Commission certainly knows that. It often busts insider-trading by monitoring atypical call option purchases on shares that later have highly positive news or takeovers announced. I notice when bids for way-out-of-the-money calls on stocks I own are attracting what seem to be overly generous premiums. That's been the case lately on shares of Children's Place . I've seen a lot of buying interest in PLCE's Jan. 21, 2022 expiration date calls at $100, $110, $120, and even $125 strike prices with the underlying shares in the $45 - $48 range. On Dec. 22, 2020 there were 18 contracts scooped up at $2.35 per share. Buyers of those calls would need to see a move to at least $127.35 on expiration day to simply break-even on that investment. Reaching that level equals a $79.35 per share rise from PLCE's Tuesday closing price. That implies a 165.3% upturn just getting even. I rarely buy calls, but I did exactly that in August when PLCE sold off sharply following its end-of-July quarterly report. The firm had a horrible loss for that period as its stores were ordered closed from late March through most of June due to Covid restrictions. I was looking ahead, not backwards, feeling that PLCE still clearly had normalized earnings power of $5 to $6 per share. I loaded up the truck when PLCE briefly went below $20 and kept buying on the rebound. I also speculated by buying some Jan. 21, 2022 $10 call options for $13 a share. My break-even was just $23 with almost 17-months left until expiration. If PLCE merely hits what was my November 2020, $83.50 goal price by then, these $10 calls will be worth $73.50 at intrinsic value. If that new call buyer of the $125 strike calls proves prescient, my $10 calls will be worth at least $115. Not bad on a $13 initial cash outlay. I wrote up PLCE favorably here on Real Money Pro. Here's the link to my Nov. 19 article. My conservative target price, with PLCE at $39.11, was about $83.50. If PLCE is indeed destined for much higher prices, it's not too late to get involved. Option-savvy traders can still set up Jan. 21, 2022 $50 buy/write combinations which offer huge upside plus a decent amount of downside protection. Here were the actual prices on the shares and its $50 calls and puts with PLCE at $48 on Tuesday. When executed in margin accounts with excess free buying power the money collected from the option sales can go toward paying for the shares being purchased. That left each 100-share commitment costing just $1,880 out-of-pocket as shown below. Come expiration day, there are just two possible outcomes. PLCE will either close at $50 or higher, or below $50. If the former situation occurs the following best-case scenario would play out. The cash-on-cash net profit would be $3,120 per 100 shares. That equals 165.9% over the not quite 13-month holding period, or 107.7% annualized. Outright buyers of PLCE at $48 would need to see it rise to $127.63 to make the same percentage gain. If PLCE somehow fails to hold $50 on Jan. 21, 2022 the worst-case scenario detailed next would unfold. You'd end up with a double-sized position, but with an average net cost of just $34.40 per share. Any decline of less than 28.3% would allow for immediate liquidation for at least a small gain. Getting 165% upside plus over 28% downside protection is a potent combination on a stock that looks good. Buy/write combos offer a beautiful way to get on board a great stock, even though the train has already left the station.

Let's Play With Unusual Option Activity

I notice when bids for way-out-of-the-money calls on stocks I own are attracting what seem to be overly generous premiums. Here's an example.

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