Chart of the Day – $KMI: Guten Morgan?

by Dan June 18, 2014 3:28 pm • Commentary

Energy related stocks have been on a tear recently from a combination of a Middle East related oil price spike and a recent round of takeover chatter.  APC have been rumored target of XOM, seeing a surge in the last couple months in call open interest, while MRO has seen considerable out of the money call buying in the last week.

Earlier today there was a fairly large out of the money call spread (bought to open) in pipeline company Kinder Morgan (KMI), where a trader bought 40,000 of the Jan 42.50/47.50 call spreads for .25 (bought the 42.5c for .28 and sold the 47.50 calls at .03) when the stock was $34.75, with a break-even at 42.75, up 23%.  The trade risks $1 million in premium to make $19 million if the stock is $47.50 or higher.

I would say two things about this trade. First, while the premium is not substantial for a large institution, the size in terms of contracts indicates someone looking to play for a home-run rather than a trade with a higher probability of success.  And second, the idea of selling the Jan 47.50 calls at .03, for a credit of $120,000 seems odd to me, aside from the fact that the trader probably had to pay close to $80,000 in commissions to put this trade on, so maybe it was simply to offset execution costs.

Either way you slice it, the buyer of this spread is buying a lotto ticket to possibly make a lot of money on the low probability event that the stock is up 36% or more on January expiration.

Taking a quick look at the chart since KMI’s 2011 IPO, it is clear that the 42.75 break-even is well above the all time highs:

KMI chart since Feb 2011 IPO from Bloomberg
KMI chart since Feb 2011 IPO from Bloomberg

This is an interesting speculative bet and worth remembering if KMI starts moving higher on news or rumors.