Earlier we detailed a large call spread risk reversal trade in shares of CMCSA. That appears to be a popular trade structure today. When shares of Michael Kors (KORS) were trading $43.80 a trader apparently made a new bullish bet in the stock looking out to February expiration, selling to open 5,000 Feb 37.50 puts ad buying to open 5,000 of the Feb 45 / 50 call spreads, resulting in a 90 cent debit, or $450,000 in premium. This trade breaks-even on the upside at $45.90, up 5% from the trading level, offering max profit potential of $4.10, or $2.05 million up to $45 with the max gain above. Between $45.90 and $45 the trader can lose up to 90 cents, between $45 and $37.50 lose 90 cents, with the worst case scenario the trader would be put 500,000 of stock at $37.50 on February expiration and suffer losses on top of the 90 cents in premium. On a mark to market basis, the position would lose money as the stock trades lower towards or below the short put strike, and would gain as the stock gets closer or above the long call strike.
The choice of strikes is interesting when you consider the stock’s performance over the last month, down more than 10% from its mid December highs. The stock is doing its bet to put in a bottom after the sharp decline, and on the upside, $50 appears to appears to be decent near term technical resistance:
On the downside, the chart has decent long term support near $38, very near the worst case downside scenario:
In this case the strategy is being employed not for a breakout to new highs play, but for a move back towards recent highs, in a beaten down stock. The short put essentially acts as a buy order below, and a move higher will be like being long stock between the breakeven of 45.90 and 50. The most common scenario is that this trade would lose 90c between 37.50 and 45, but above 45 and below 37.50 it’s like owning stock.