New Trade Groupon (GRPN): A Very Rare Options Opportunity

by Enis May 14, 2012 2:58 pm • Commentary

First off, a disclaimer.  I know about as much about the fundamental story of Groupon as the average Joe on the street who does not follow stocks.  I have not followed this stock closely since its IPO, and only know the general themes that have led to a steep selloff since its IPO last year.  However, when I took a peek at Groupon options pricing today ahead of the earnings report after the close, I was surprised to find a rare opportunity in the options market.

Before continuing, I have a second disclaimer.  This trade involves a complex options structure that is for very advanced traders, but I want to present it here for everybody as it is a useful educational exercise.  I do not think it makes sense for most traders to try to replicate the trade laid out below, even if you agree with the thesis.  Without further delay, here’s the trade:

The options for Groupon are pricing in a 20% move for this week, based on the May 18th expiry straddle.  But more interesting to me was the high premium embedded in the farther out expiries.  The July 11 straddle is $4.25 bid, which implies a 35% move in 2 months.  That is some serious premium.  Yet, I didn’t want to take a naked bet that the stock might not move that much, because again, I didn’t have any special information about the company and it’s been up over 20% today alone.  So there was one final aspect of the options term structure that made me take comfort and initiate a new trade.  The upside calls were actually quite cheap since the stock is hard to borrow.  Why is that important?

There are several inputs to an options price, one of which is the “borrow rate” of the stock.  Kristen has written a section in our Education tab with details about hard-to-borrow stocks – scroll down the page to find the hard-to-borrow portion here – but I’ll elaborate a bit more for this section.  Since the stock is hard-to-borrow, we don’t want to be left naked short the stock, so we need something to protect the short call portion of our short Jul 11 straddle (again, a straddle is short a put and a call of the same strike).  The Jul 15 calls offered at $0.65 are what caught my eye as decent upside protection.  If I bought that, I would be flattened out of my Jul 11 straddle risk at $15.65 or higher in the stock.

Here’s the trade:

TRADE: GRPN ($11.86)

-Sell the Jul 11 put at $2.55

-Sell the Jul 11 call at $1.70

-Buy the Jul 15 call at $0.65

Total premium collected:  $3.60

Since I’m protected above $15.65, what is my main risk on this trade?  Well, I collected $3.60 in premium upfront, so my main risk is if GRPN goes below $11 – $3.60 = $7.40.  If GRPN stock goes below $7.40 before July expiry, then I will lose money.  If not, I plan on taking the whole structure off at some point before July expiry because I have no interest in owning or being short GRPN stock.

Part of the reason why this trade appeals to me is that GRPN short interest is 44% of the stock’s free float, and GRPN is already down almost 50% this year.  The risk of GRPN selling off below $7.40 seems relatively low to me, and I make money in almost every other scenario, so the risk/reward seems exceptional.  Again though, please read my 2 disclaimers at the start of this post.  This is not a trade for the beginner trader.