How and why is the Trader in the following situation expecting to profit from his actions?
Several years ago in the trading pits at the CBOE, a trader from a large brokerage firm would cone onto the floor of the exchange and cry out an offer to purchase 1,000 put contracts of his firm's options the day before earnings each quarter. How and why is the trader expecting to profit from his trade?
Answers
2183 points
ChaosNantuko answered one year ago …
Frequently stocks increase significantly in price prior to earnings being released, because people EXPECT earnings to be good. If earnings come out even slightly less then expected, everyone who bought before earnings will sell, and the stock price will go down. If he was banking on that thesis, that could be his rational.
Another possible cause is that he has a very large stock position in the firm. If he does, then these put options may actually be "protective puts", to insure that if the price does go down, he won't loose too much money. Admittedly, this seems unlikely, because 1000 put contracts would cover a million shares, and not many traders hold a million shares of a company.
for more info on protective puts, go to http://www.888options.com/strategy/protective_put.jsp
Another possible reason is that he's buying at one strike price, and selling them at another. This would be known as a "vertical spread". This may well be the case, because many people prefer establishing a vertical spread for a credit, and when a bullish vertical spread is established using puts, it is done for a credit. In this case, even though he is using puts, he still makes money if the stock goes up.
for more on vertical spreads using puts, see http://www.poweropt.com/bpspreadhelp.asp
as a bit of an aside, that sounds like a textbook case of insider trading.
119 points
ChuckS answered one year ago …
Bernie Schaeffer has a service in which he tells people to buy put or call options before earnings, based on technical, fundimental, and sentiment analysis. I'm not sure how successful he is, but the EMail I got promoting it gave 2 recos that did work.
Chuck S
244 points
KenLong answered one year ago …
Is this a real question? Or just some anecdote borrowed from someones options quiz? Try to keep the questions real.
Usually people buy puts because they expect the price of the underlying to drop. Maybe the trader knows something we dont and thinks the expectations for the stock are too high and it will come back down after earnings are reported. Maybe he's playing games and trying to manipulate prices by giving off the image that he knows something.
Does he buy these, or is it a ruse to get others to act. Does he trade them for a profit, or are they intended as an insurance hedge to protect a large holding from a percieved drop in price. Maybe he's already short the position and its a closing trade before earnings are anounced.
There are a lot of variables and a lot of possible answers for a obviously phony question.
This isnt Ask Marylin in the sunday paper. Please keep the questions real and pertinent or you waste precious time. We all have something else to do.
