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Call spread in Palo Alto Networks

David Russell (david.russell@optionmonster.com)

Palo Alto Networks has pulled back to levels from its initial public offering, and the bulls are stepping in.

optionMONSTER's Heat Seeker monitoring system detected the purchase of 1,500 March 60 calls for $2.15 and the sale of 3,000 March 70 calls for $0.45. Volume was more than 5 times open interest at each strike.

The position cost $1.25 and will earn a maximum profit of 700 percent if the maker of network-security systems closes at $70 on expiration. Gains will erode above those levels and turn to losses over $80.

The trade is known as a ratio spread because twice as many calls were sold as the number purchased. That increases the leverage by lowering the cost basis but also creates the risk of losing money above a certain level.

In the case of Friday's trade, this decision appears to make sense based on PANW's price chart because it peaked around $70 in September. The price action could have made the investor doubt that big gains will occur above that level.

The trader may have also bought the stock for about $70 and is now sitting on a losing position. Using the ratio spread would let him or her leverage a rebound back to that level, and above it the short calls will be offset by the shares already owned. (See our Education for other ideas on how to repair trades using options.)

PANW rose 3.6 percent to $53.25. It went public for $42 a share in July but immediately shot above $50. It rallied for the next two months before pulling back to that same level from its IPO.

Total option volume was 11 times greater than average in the session, with calls outnumbering puts by 8 to 1.

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