Follow This Massive Downside Trade with a Potential 1,100% Return

High-Yield Investing, Options, Technical Analysis

One of the most interesting aspects of options trading is that you never quite know what traders are thinking when they make trades.  It’s difficult to be 100% sure of their goals when they initiate a certain positon.

Part of the mystery is due to how flexible an investment options can be.  Perhaps more importantly, options are often paired with stocks (or futures) to create an entirely different of type of strategy (than with options alone).

For instance, you may be researching options trades and come across a short call trade.  On its own, a short call is a bearish or neutral trade on the underlying instrument.  However, if that short call is paired with long stock, it becomes a covered call, which is a moderately bullish trade.

Another common example of this scenario is with long puts.  A naked long put is a bearish strategy.  However, pair that long put with long stock and it becomes a hedge, or downside protection.  In that case, the put buyer would prefer the stock to go up and is just placing the long put to lower risk (or preserve capital).

So you can see, it’s generally not obvious what the goal of a particular options trade is.  We can do our best to take an educated guess on what it means – but there could be more going on behind the scenes that we’ll never know.  That’s one reason why it can be very beneficial to have a coach or mentor who has lots of experience studying the options market.

Here’s the thing…

A huge trade hit the wire this past week, and it’s one of those trades where the goal of the strategy is quite uncertain.

The trade I’m referring to is a January 2019 put spread in Starbucks (NASDAQ: SBUX) where the trader bought the 40 puts and sold the 35 puts for the cost of $0.37 (with the stock at $56).  This put spread was executed a whopping 92,300 times, which puts the premium cost (max loss) at $3.4 million.

And since I’m sure you’re curious, the max gain is at $35 or below by next January.  In that case the position would be worth $4.63 or $42.7 million (a potential return of over 1,100%).  We’re obviously talking about a trader (probably a firm) with a lot of capital to throw around.

So the question is, is this put spread a huge bearish bet on SBUX, or is it a hedge against a very large amount of long stock?

In this case, it’s a very interesting question because I don’t think the answer is obvious.  Typically, when large amounts of put spreads are purchased like this, they are being used to hedge a long position.  You see this sort of trade in index ETFs all the time.

On the other hand, I personally would expect a hedge to be closer to the stock price of $56.  Something like the 45-50 put spread seems to me like a more likely hedge.  Now, that’s not to say this isn’t a hedge.  Someone with complex risk modeling software may have determined that 35-40 is where they need to be hedged if they are long a large amount of SBUX shares.

Still, given how far the put spread is from the stock price, how cheap it is, and how long we have until expiration, I would not be shocked if this was bearish bet on SBUX.  The company has been struggling lately, as you can see form the chart.

If you’re long SBUX shares and you want to hedge, I’d recommend higher strikes.  If you’re betting on a bearish move and want to buy about a year’s worth of time on the strategy, this trade is not a bad way to do so.

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