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'Synthetic' trades abound as bulls run

David Russell (david.russell@optionmonster.com)

Traders got bullish in a big way yesterday, deploying leveraged positions on myriad stocks.

Polycom, which makes telephone headsets and videoconferencing systems, crossed our Heat Seeker system less than 25 minutes after the open. The strategy involved the sale of 4,000 April 17.50 puts for $0.75 and the purchase of 9,000 April 20 calls for the same price.

The resulting position is highly bullish: Selling the puts lets the investor own 4,000 upside calls at no marginal cost while exposing the trader to losses if PLCM falls below $17.50. The investor also owns 5,000 calls outright, which will make money in the event of a rally. The stock rose 2.54 percent to $18.99.

About 50 minutes later, 13,000 October 4 calls were bought in Office Depot for an average premium of $0.375, and a block of 2,500 January 3 puts was sold for $0.50. Large trades occurred against open interest at the same time in the July 3.50 calls and the April 3.50 puts, which indicates that an existing long position was closed and rolled forward. It was also more than doubled in size. ODP closed at $3.41, up 6.56 percent on the session.

Both trades were variations of " synthetic " long strategies, so named because options are used to simulate owning stock. They combine the principles of selling protection and buying calls , both of which benefit from higher share prices. Writing the puts generates income and obligates the trader to buy shares if they drop, like providing insurance on a house you don't think will burn down. (See our Education section)

Buying the calls lock in the price they must pay for the shares, so they can appreciate quickly in the event of a rally. The income from selling the puts also reduces the cost basis of those upside contracts, resulting in even more leverage.

Minutes after the trade in ODP, bulls set their sights on Viacom, parent of media companies such as Paramount Pictures and MTV. This time they bought 6,500 January 55 calls for $1.90 and 1,500 January 55 calls for $3.70 while selling 8,000 January 40 puts for $2.30. The trade will start making money above $50, with major gains kicking in above $55. VIAB, which has never traded above $53, rose 1.56 percent to $48.03.

The next trade occurred in kitchen-supply retailer Williams-Sonoma in the early afternoon. About 2,600 May 40 calls were bought for $0.68 and a matching number of May 32 puts were sold for $0.64. The interesting thing about this transaction is that the investors benefited from higher implied volatility in the puts to collect a small credit of $0.04. They now stand to earn unlimited profits if WSM rallies above $40, and won't lose money unless it drops below its January low to test $32. The shares rose 2.35 percent to $36.54.

The Heat Seeker detected the last transaction during the final 90 minutes of trading in the Select Sector Industrial exchange-traded fund. About 23,000 April 40 calls were bought for $0.05 and a similar number of April 32 puts were sold for $0.12. It also resulted in a small credit, this time of $0.07. The XLI, which closed at $37.78, would have to climb almost 6 percent in the next 5-1/2 weeks for the calls to go in the money .  

Given the recent bullishness in the market, it almost appears to be an insurance policy that will protect the investor from missing a rally in the near term. The fund tracks a wide range of major blue-chip companies such as General Electric, United Technology, and Caterpillar.

(Portions of this post appeared on InsideOptions Pro in real-time yesterday.)

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