New Trade: Caught Staring at $RAX

by Dan January 15, 2014 2:36 pm • Commentary

Yesterday an interesting options trade went up in stock that we don’t usually see interesting options flow in, Rackspace (RAX).  RAX is a $5 billion market cap web hosting company, oh and yes you can use the magic term cloud in many of the business offerings! The stock had a horrible year in 2013, nearly cut in half after a string of earnings disappointments.

But one trader sees a slightly rosier reception for the stock in the early part of this year. Yesterday afternoon, right before the close, someone:

Trader bought to open the RAX ($35.99 stock reference) Feb 30/42.50 Risk Reversal for .35

-sold 7,000 Feb 30 puts at .55 and

-bought 7,000 Feb 42.50 calls for .90

Break-Even on Feb Expiration:

Profits: above 42.85

Losses: btwn 30 and 42.50 lose the .35 premium paid for the structure, below 30 buyer is put the stock plus loss of .35 premium

Make no mistake, this is a fairly bullish trade, but let me emphasize fairly.  The trade had about a 40 delta to it, so the trade offers a lot of leverage for a big upside move, but the width of the strikes means there’s a strong likelihood of the stock being somewhere between and worthless on Feb expiration without any significant gaps higher or lower.

The trade caught our eye because of the seemingly washed out nature of the chart.  The one year chart below shows what could amount to a fairly feeble attempt at putting in a low, as the stock today approaches it’s declining 50 day moving average (circled) which could serve as near term resistance.

RAX 1 year chart from Bloomberg
RAX 1 year chart from Bloomberg

On a longer term basis though, the sale of the $30 strike put becomes kind of evident, as the stock has not traded below there since 2010, prior to the stock’s breakout and subsequent 170% rally over then next 2 years.

RAX 5 yr chart from Bloomberg
RAX 5 yr chart from Bloomberg

The choice of expiration is not too much of a mystery as the company is confirmed to report their Q4 results on February 10th.  As stated above, the stock has had some fairly dramatic moves in the last year following results, with an average one day move of about 16%, with the smallest an 8% gain and the largest a 24% decline.

Sentiment for the stock is mixed at best with short interest at about 15% of the float, while Wall Street analysts remain on the fence with 10 Buys 13 Holds and 2 Sells.

On a Vol basis, it has been increasing in manner that suggests that it will be trading towards the highs of the last 2 years by the time it gets to next month’s report (obviously yesterday’s trade help goose implied vol in feb).

RAX 2yr at the money Implied Vol from Bloomberg
RAX 2yr at the money Implied Vol from Bloomberg

Vol continues to tick up today as buyers remain, 4,000 of the Feb at the money 37.50 calls have already traded.  We are not ones to chase unusual activity, but the prospect of better 2014 guidance and or some combination of take-over speculation could have this stock in the mid 40s fairly soon.  That being said we want to play with options as a miss and a guide down likely sees a the stock in the low 30s.  

TRADE: RAX ($37.93) Bought March 40/50 Call Spread for 2.00

-Bought 1 March 40 Call for 2.55

-Sold 1 March 50 Call at .55

Break-Even on March Expiration:

Profits: btwn 42 and 50 make up to 8 with max gain of 8 above 50

Losses: btwn 42 and 40 lose up to 2, with max loss of 2 below 40

Trade Rationale: This is a speculative trade in a volatile stock, so we want to define our risk and risk what we are willing to lose.  We also hate chasing stories, so we are going to start small, and look to add on a pullback.