Interpreting Unusual Options Activity

Jason Ayres
October 4, 2013
9 minutes read

Agrium Inc. (TSE:AGU) made the Montreal Exchanges “most active” list on Wednesday. This list can be found at m-x.ca under the trading Activity header by clicking on the Most Active options tab. Based on further investigation of the historical data available for Wednesday, October 2nd, it appears as though there was almost double the volume on the call side when compared to the put side. The additional call activity focused on the January 2014, 88 strike calls which was 4 times the volume of the second most active call contract found at the November 96 strike call. Now, one would assume that this denoted a bullish sentiment on the stock. However, it is not always as simple as that. Further investigation of yesterday’s trading activity also uncovered a substantial number of contracts traded on the put side at the January 2014, 88 strike. The numbers were a mere 16 contracts shy of the call side.

Stocks can experience unusual activity on the underlying option contracts for a number of reasons:

  • Institutional buying selling
  • Anticipated merger, acquisition
  • Speculation

It is important for the investor not to simply make assumptions. The options market is used to accomplish a number of objectives and the interpretation of unusual activity in any one contract can often be subjective. While these observations have historically preceded significant moves, it is important to dig a little deeper.

For example, a simple search of the headlines revealed two noteworthy items.

The first indicated that Agrium has completed that acquisition of Viterra Inc’s Canadian retail Assets. Agrium is a fully integrated fertilizer and plant nutrient provider that takes the product from the mine to production and on to the grower. Viterra essentially partners with grain growers to help store, market and distribute their products. Agrium has just sealed the deal to acquire:

  1. Certain crop input retail centres, fertilizer and ammonia storage and distribution assets
  2. Viterra Financial™ arrangements related to crop input retail centres
  3. Viterra’s interest in Interprovincial Cooperative Limited
  4. Western Canadian fuel business, in accordance with certain provisions

For source information and more details visit www.viterra.com

This is viewed to be a positive move for Agrium, and the completion of the acquisition on October 1st bodes well for the future growth potential of the company and may therefore be interpreted as bullish for the stock.

The second and more recent headline indicated Agrium’s CEO Mike Wilson retirement at the end of the year. So come January 2014, COO Chuck Magro will take the helm.

A review of Wilsons 10 year history with the company indicates a 500% gain in share price under his leadership…all be it not in a straight line. This was overshadowed in 2012 by Agrium’s largest shareholder, Jana Partners, attempt to shake up the board and challenge Mike’s leadership. The intention was to influence Agrium to spin off its retail arm as a separate company from its fertilizer business. The intention was to unlock shareholder value but the idea was rejected.

This year the shares have fallen from a high of $115.00 to a low of $82.00, influenced moderately to the downside by the Russian fertilizer cartels break up in the summer. Agrium’s last earnings yielded warnings of lower sales and profits for the third quarter and a hike in the dividend. All things considered, the shares currently hover at $87.00 and a look at daily price chart reveals support at $85.00 and an upswing which may be the start of a bullish run.

agrium weekly

With the closing of the Viterra deal and the new CEO on deck for 2014 it appears as though Investors might be testing the waters at these levels.

So, what does this have to do with the unusual activity in Agrium, January 2014 88 strike calls and puts?

Without knowing if the volume was on the buy side or sell side, it is difficult to pinpoint the exact strategy. For example, an investor may have implemented a strangle buy purchasing the calls and puts with the same strike and expiration, or a synthetic stock position may have been created by selling the puts while purchasing the calls.

Let’s assume that a large investor wished to take a bullish stake in Agrium and believed that $88.00/share is a good price to own it at. A synthetic long stock position could be created by simultaneously selling puts and purchasing calls at the same strike price and expiration month. The position has the same risk/reward profile as a long stock position for the lifetime of the options.

The prices on the day of the unusual volume were as follows:

Stock: $88.30
January, 88 strike call: $6.35
January, 88 strike put: $4.95

The investor could sell 1, 88 strike put and collect $4.95/share. This would create an obligation to purchase 100 shares of Agrium at $88.00 if the shares drop below this value.

The premium collected could then be used to purchase the 88 strike call for $6.35. This gives the investor the right to own 100 shares of Agrium at $88.00.

If you consider the credit collected from the put and apply it to the cost of the call, the total cost for the synthetic long stock position is $1.40/share.

The breakeven on the position to the upside is the 88 strike plus the net premium if $1.40. The stock must be trading above $89.40 for the investor to profit.

The risk is unidentifiable and losses occur as the share price breaks below the written put. The investor has an obligation to buy the shares at $88.00 and incurs a loss anywhere below this price point.

It should be noted that there are margin requirements associated with shorting the put option to construct the synthetic stock position. The initial requirements are almost the exact same as if you were to purchase the underlying shares. However, as the shares move higher, your margin requirements on the stock position will remain the same while your obligation to the short put margin requirements will decrease as the position becomes profitable.

The important consideration is that is one reason why there would be such unusual volume on calls and puts of the same expiration month and strike price. It simply fits the criteria required for the construction of a synthetic stock position.

As I suggested at the beginning, unusual option volume is open to interpretation as investors employ calls and puts to meet many different objectives.

Unusual volume on stock options should be used as a trigger point to investigate further. Once identified, the investor must dig deeper and draw their own conclusion. Once a bias has been reached, a strategy should be selected to compliment the outlook. Regardless of where you find your opportunities, your primary focus must always be risk management.

Jason Ayres
Jason Ayres http://www.croftgroup.com/

CEO and Director of Business Development

R.N. Croft Financial Group

Jason is CEO and Director of Business Development at R N Croft Financial Group, a member of the Croft Investment Review Committee and a Derivative Market Specialist by designation. In addition, he is an educational consultant for Learn-To-Trade.com and an instructor for the TMX Montreal Exchange.

65 posts

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Scroll Up