On any given trading day of late, single stock put volumes tend to be dominated by energy related trades. Investors in energy stocks, especially stocks whose equity declines have exposed the high levels of leverage, in an economic environment that shows no signs of increased demand, and less supply of commodities, now seem to be preparing for worst case scenarios. In most of those worst cases, it means that equity values go to near zero, and then preferred and debt. Obviously that happens in a re-organization, or a bankruptcy, but there are tons of examples where investors have become rolled down equity option protection, down to levels that seem fairly compressed. Take Chesapeake Energy (CHK) for example, a stock that is down 33% year to date, and down 85% from its 52 week highs, with the stock a little over $3, investors are still rolling down puts from higher strikes as the stock cascades lower.
Shortly before noon when CHK was $3.25, a trader sold to close 7500 Feb 4 puts at 99 cents, or $743,000 in premium, and bought to open 15,000 of the Feb 3 puts for 43 cents to open, or $645,000 in premium. You see what the trader did there, took the gains from 7500 contracts and was able to roll down to the next strike, but double the amount of contracts and pocket some of the profit. I suspect these puts are a hedge against an existing position, either in equity or debt.
Taking a quick look at the capital situation of CHK, it becomes clear that the equity to debt ratios are getting worse, fast. From the end of 2014 CHK’s market cap has declined by 85%, while its cash position has declined 57% while its debt and preferred equity has stayed put. You get why when considering what a reorganization means for equity holders.[caption id="attachment_60390" align="aligncenter" width="600"] from Bloomberg[/caption]
A quick look at the 20 year chart shows the stock making 16 year lows. At some point very soon it won’t make a ton of sense to buy 43 cent options in CHK 🙁[caption id="attachment_60391" align="aligncenter" width="600"] CHK 20 year chart from Bloomberg[/caption]