Name That Trade – $GE: Electric Boogaloo

by Dan February 27, 2015 3:34 pm • Commentary

The largest trade on the day across single stock, etf and index options was a long dated bullish trade in GE.  When the stock was $25.93 a trader paid .52 for 125,000 of the Jan2017 30 /35 call spread to open, spending $6.5 million in premium for long exposure in between $30.52 and $35 on Jan 2017 expiration with a break-even up 18%, and a max gain of $4.48 (17.5% of the underlying stock price) or about $56 million if the stock is $35 or higher, up 35%.

I suspect this trade was to add leverage for an investor with an existing long position, as the spread offers a 10 to 1 pay out in a stock that is not particularly known for dramatic movement.

Some of you may be thinking that sort of capital commitment is the exact sort of thing you want to chase. I would actually take the other side of that argument and suggest that while these long dated options are definitely dollar cheap there are probably better ways to make a play for a catch up in the under-performing industrial. The reason I mention this is that more than 7,000 of the Jan2017 calls have traded (most look to be bought to open) after the call spread traded as smaller traders appear to be piling in.

Thinking about it another way, the Jan17 30/35 call spread is now worth about 65 cents with the stock at $26.10.  Obviously a lot of things have to happen to make money on this trade, but the the mere fact that there are two years to expiration is a bit of a double edged sword. The lower the stock goes in the near term, the more that time will be your friend, the sooner the stock goes there the longer the investor has to worry about the risk reward. Right now it looks like a great risk reward as the spread has only 16 deltas, but if the spread was in the money then those deltas would be much higher. And holding long dated in the money options is very different than those out (you have to wait on the profits and sometimes that can tie your hands). Obviously this is a high class problem to have, and if it is a leverage play to long stock than it is a home-run as the investor will have massive gains int he stock and the added juice of the calls.

Taking a quick look at the technicals, the timing of today’s bullish trade is interesting as it was just a few weeks ago that GE looked as if was going to make new 52 week low:

GE 2yr chart from Bloomberg
GE 2yr chart from Bloomberg

Despite the 12% bounce in the last couple weeks, the stock is only up 3% for the year and remains in a downtrend since December 2013, making a series of lower highs and lower lows.

On a longer term basis though, looking at the 8 year chart below, there is no real overhead resistance until the prior highs made in late 2013 for another 10%, and then little above:

GE 8yr chart from Bloomberg
GE 8yr chart from Bloomberg

So for those who think the stock is poised to make a run to multi-year highs I would suggest that it may be a better play to look to shorter dated options that capture some potential near term catalysts.  The company will be speaking at two brokerage conferences in March, hosting a Technology Investor meeting on March 11, reporting Q1 earnings on April 17th and holding their annual shareholder meeting on April 22nd (via IR site here).

The stock is cheap, trading at only 15x expected 2015 earnings growth of 5%. It pays a dividend that yields 3.5% and actively buys back their shares. With 55% of their sales coming from overseas the company is obviously struggling with the effects of a strong dollar, and their exposure to emerging markets has kept investor sentiment at bay.

And short dated options are cheap, with 3 month at the money calls trading at 15 vol:

GE 1yr chart of 30 day at the money IV from Bloomberg
GE 1yr chart of 30 day at the money IV from Bloomberg
Hypothetical Trade: GE ($26.05) Buy to open May 26 calls for .80

Break-Even on May expiration:

Profits: above 26.80

Losses: up to 80 cents between 26 and 26.80 with max loss of 80 cents below 26, risking about 3% of the underlying stock price.


But ¯\_(ツ)_/¯