New Trade – $RIG: Rolling in the Deep

by Dan March 11, 2014 12:56 pm • Commentary

RIG is holding up well this week despite weakness in crude oil (and broader commodities, like copper) and the oil sector of the stock market.  Dan highlighted the unusual activity in RIG options in last week’s MorningWord post below, and we have posted on several occasions about the fundamental valuation of RIG as well as the company’s business prospects.  

The stock has held the $40-$41 support area despite a lackluster earnings report in late February.  At 0.91x book value, a lot of bad news is priced into RIG shares by market participants.  Moreover, the technical situation suggests that even if the stock does move higher here, it’s unlikely to be a fast, breakout move on the upside:

[caption id="attachment_37362" align="alignnone" width="600"]RIG daily, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg RIG daily, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

RIG has a declining 50 day ma, now around $44.75, and a declining 200 day ma, now around $47.45.  The stock has also been unable to get above the Sept-Oct lows around $44.

Technically, RIG has ample resistance on the upside, but its very cheap valuation is likely to provide downside support.  We own the stock in our investment portfolio slightly higher. With no major catalysts on the horizon, we like a range trade with a bullish bias that targets the $42-$48 range. This structure works well against the long to add yield back towards our breakeven, but the structure works well as a long delta range trade on its own:

TRADE:  RIG ($42) Buy the Apr19th 41/45/49 call butterfly for $1.32

– Buy 1 Apr19th 41 Call for $1.90

– Sell 2 Apr19th 45 Calls at $0.34 each ($0.68 total)

– Buy 1 Apr19th 49 Call for $0.10

Break-evens on Apr19th expiration:

Profits: btwn 42.32 and 47.68, make up to 2.68, with max gain of 2.68 at 45

Losses: losses of up to 1.32 btwn 41 & 42.32 and btwn 47.68 & 49 with max loss of 1.32 below 41 or above 49



MorningWord 3/7/14:  Drilling Into $RIG Activity

On last night’s CNBC’s Fast Money I highlighted some unusual activity in Transocean (RIG) where options volumes ran about 2.5x the average daily volume of the last month. What stood out to me was a buy of 10,000 May 41 puts to open for 1.09 vs buying  about 300,000 shares of RIG for 42.97.  We highlighted the trade as bearish because it was a buy of puts that had only a 30 delta to them, but I also highlighted the relative cheapness in implied volatility.

On Twitter I got a good question about my take on the activity so I thought it made sense to clarify my observations. Once again, discerning unusual options activity can be guess work, and we are not fans of making trading decisions blindly on options flow (read our post last month Unusual Options Activity: Why it Can Matter & Why it Usually Doesn’t):

@RiskReversal @CNBCFastMoney $RIG Bearish?…. 15,000 May $46 calls bought in two days- May $41 Puts bought vs. 306K stock Delta Neutral

— Joe Kunkle (@OptionsHawk) March 7, 2014

So this trade could have been conceived for a whole host of different reasons, but it was likely one of two.

First the trader wanted to make a defined risk directional bet, but was happy to do so tied to stock, and work out of the stock position once the trade was up.  Large institutions will often do this because it will help them get a better price and higher capital commitment from the market maker who will take the other side of the trade. I’ve worked on a large institutional options desk in the past and this practice goes on all the time.

The other logical explanation for the trade was that a volatility trader viewed May expiration in RIG to be cheap and specifically this strike and felt that if the stock were to move one way or another the trader will be able scalp stock around the options position, buy more as the stock goes down, or sell some that he owns from the initial trade as the stock goes higher.

The main takeaway for highlighting the trade is that options volume is picking up at a time when the stock could be at a technical inflection point.

Look at the one year chart after recently making fresh 52 week lows, with prior support at $44 now becoming important near term resistance:

RIG 1yr chart from Bloomberg
RIG 1yr chart from Bloomberg

The fourteen year chart (below) is the one that highlights just how poor the stock’s relative performance has been to the broad market and its peers as it bangs along 10 year lows, on MASSIVE long term support:

RIG 14 yr chart from Bloomberg
RIG 14 yr chart from Bloomberg

The 3 year chart of 30 day at the money implied volatility (blue) vs the 30 day realized volatility of RIG shows why a savvy vol trader may be inclined to play for movement in either direction as realized (how much the stock has moving) as picked up of late, while implieds remain just off three year lows:

RIG 3yr chart of 30 day at the money IV (blue) vs realized (white) from Bloomberg
RIG 3yr chart of 30 day at the money IV (blue) vs realized (white) from Bloomberg

I would also add that prior to making my observations about options flow in RIG yesterday, I had not looked closely enough at the activity in the name from earlier in the week.  As the OptionsHawk suggested in his tweet, there appeared to be opening buyers of April and May calls on Wednesday with the largest block a buy of 7400 May 46 calls for .70 to open, now making the May 46 calls the single largest line of open interest with 15,000 options and the May 41 puts the second largest with 11,600.

This activity makes it likely that traders are betting that RIG is at a moment of truth on its chart that isn’t being reflected in the options. We’ve made these types of trades before where a stock is at a point where it either fails at highs or breaks out to new highs. RIG is very similar but at lows.

So I appreciate the OptionsHawk’s eagle eye and the opportunity to expand on the options flow. Again, we identify unusual options flow as one input in our idea generation process and if I hadn’t seen yesterday’s put purchase, regardless of the traders intention, or anothers opinion of whether it was bearish, bullish or neutral. It has me looking at a very interesting development in the stock that I would not have known about otherwise.

We own RIG in the investment portfolio and this activity means we’ll start to look at structures around that stock position as people seem to be sniffing around in the name now.  Oh and Carl Icahn is the third largest shareholder, the guy has had a bit of a hot hand of late.