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These stocks signal a potential rise in prices. There is unusual call option activity in their shares, often associated with an upcoming higher price. This is a very simplistic and rough tool. A more accurate indication of value would be a fundamental analysis of the company’s finances. One example would be a falling inventory line and negative working capital. These would indicate that sales are rising going forward.
But I thought that for short-term traders, investors can rely on a huge increase in call options, often before an earnings release or a dividend declaration. This often, but not always, leads to higher stock prices. One reason is that the hedge fund or individual making this bet might try to push the call option higher through large volume stock purchases.
Keep in mind that I am not using a version of the oft-used put-call ratio (PCR). That is a sort of contrarian indicator. This is simpler and to the point. Huge call options activity tends to push up a stock price in the near term. Anything can happen after that.
Let’s dive in and look at these stocks.
Bank of America
Potential Rise Stocks
The stocks above had large moves in their call options that are around at least a month away (July or later — except for one with a June 17 expiration).
Source: Mark R. Hake, CFA, and Barchart.com
For example, using tools provided by barchart.com, you’ll note that the volume for the Carvana (NYSE:CVNA) stock had 7,651 call option contracts traded on June 7. Compared to its open interest of just 126 contracts, the Vol/OI ratio is 60.7x (i.e., 7,651/126 = 60.7). That implies that the open interest will climb by 60.7 times its existing base of open contracts.
In other words, the owners of the July 15 CVNA calls expect to see the CVNA stock rise quite significantly sometime within the next month or so. That is interesting since the next earnings release from the company will likely occur within the next month for the quarter ending June 30. For example, last quarter, the company produced its earnings by April 20 after the end quarter-end.
The same is true for the Metlife (NYSE:MET) calls. They show that there is a large Vol/OI ratio just after the quarter end and expire in time before the expected earnings for Q2 are released.
Where This Leaves Investors
These call options are almost certainly the result of major hedge fund activity. That is probably the only real reason that the Vol/OI ratios moved so dramatically higher, at such a quick pace. This allows us to review the options’ potential rise.
These call options imply that underlying stocks have a potentially huge upside. For example, the investors in the call options expect that the stocks will likely make big moves. Their purchase of the call options is a way to leverage the investment in the stock in a big way.
If they assume that there is a reason the stock price will rise, it would be better to own call options. But to do this there has to be a good reason or a good probability that the stock will rise.
These Volume/Open Interest ratio numbers are very high. Think about this. The investors in these calls knew that buying such huge volume in the calls compared to their open interest would begin to move the price of the calls higher. In addition, they must have had a huge degree of confidence.
This is why I have found that the unusual activity in these stocks could lead to a major rebound in these potential rise stocks. For example, Carvana stock has to rise well over 30% on or before June 17 for the owners of the call options to make a profit. That could be a bit risky, but the buyers must think there are some reasons to believe it could happen.
Bank Stock Call Options
The two bank call options for Citigroup (NYSE:C) and Bank of America (NYSE:BAC) are also less risky call option bets. Both of these call strike prices are in a “near-the-money” position in relation to today’s stock price, and in addition, they are both set for July 8. This means that the investors who bought these calls are likely expecting the market to believe that the end-of-quarter earnings will be better than expected.
Note how I said this. They expect the market to believe earnings will be better. That may not actually be the case, since the strike expiration date is before the companies will report their Q2 earnings.
In effect, then these two bank stock call option plays are a bet on the old Wall Street saw: “buy on the rumor, sell on the news.” They expect to see money center bank stocks rise in anticipation of better-than-expected Q2 earnings.
This shows how hedge funds get involved with these unusual call options. This can lead to a potential rise in the underlying stocks if the investor is alert and takes advantage of the opportunities.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.