Credit-based options strategies such as the bull put spread are powerful, but they can also be incredibly risky if you’re entering the arena in a haphazard way. Case in point is Walgreens Boots Alliance (WBA). As an interesting but wildly volatile security, WBA stock is not for the faint of heart. That said, the underlying implied volatility (IV) relative to its historical volatility (HV) will almost certainly tempt retail options traders.
Just as a quick refresher, IV represents the anticipation of market movement. Therefore, when the metric is significantly above HV, it indicates an expectation of far greater kinesis than normal situations for the asset would engender. Put another way, the premium for selling options is much greater, which can be a useful indicator — so long as you select the right trade.
Right now, the average IV for WBA stock stands at 84.08%, well above its HV of 36.3%.
Still, the fact of the matter is that elevated IV cuts both ways. If the underlying security moves but moves in the wrong direction, your position risks getting blown up badly. Now, the benefit of net credit strategies such as the aforementioned put spread is that the downside is defined and limited. However, since you typically must risk many multiples of the reward you receive, a maximum loss could ruin accumulated profits in other trades.
Generally, then, you want to be extremely cautious about ultra-volatile entities like WBA stock. Should the market move against you in a credit spread, it can be lights out. At the same time, if you already were planning on speculating on Walgreens, there’s probably only one trade to consider.
WBA Stock Makes the List of Unusual Options Activity
On Monday, WBA stock represented one of the top highlights in Barchart’s screener for unusual stock options activity. This data interface is a useful tool in identifying the public companies that have caught professional investors’ attention for one reason or another.
Specifically, Walgreens’ options volume reached 229,391 contracts versus an open interest reading of 904,326. This metric represented a 315.41% lift from the trailing one-month average volume. Further, on the call side, there were 154,341 contracts versus 75,050 contracts for puts. On paper, the put/call volume ratio landed at 0.49, which seemingly is bullish.
Unfortunately, at time of writing, Barchart’s options flow screener was unavailable. While difficult to get a true sentiment reading, data from Fintel indicates significant premiums paid for put options and premiums received for call options. Therefore, the sentiment among major investors could be bearish. Whatever the case, we do know that on Monday, WBA stock dropped 2.28%.
While Walgreens has been a chart loser for several years, there’s also a logic that states that — at least temporarily — the pessimism has been baked in. If that’s the case, writing a contrarian credit spread may be quite lucrative given the strong sentiment for the negative side of the trade. If shares stay sideways or don’t fall as much as expected, it’s possible to generate income.
Of course, I wouldn’t want to risk writing a naked put so a limited-reward, limited-risk bull put spread would be “ideal” in the context of this speculative proposition. But with so many spreads available, which one should you choose?
Arguably, there’s really only one answer.
Focus on the 8/7.50 Bull Put Spread
Based on Barchart’s available bull put spreads for the Oct. 18 options chain — which currently features IV of 165.65% over HV of 36.3% — the 8/7.50 spread appears to be the most sensible (again, under the context of extreme speculation). This trade involves the following:
- Sell the $8 put at a bid of 22 cents.
- Buy the $7.50 put at an ask of 12 cents.
- The difference of 10 cents represents the maximum reward.
- The most we can lose in this trade is 40 cents.
- The yield comes out to 25%.
- Breakeven lands at $7.90.
It’s true that the 8/7 put spread features a lower breakeven price of $7.84. However, such a modest increase in safety margin relative to the difference in reward (a 25% yield versus only 19.05%) means that there’s less money at risk for the 8/7.50 spread.
Moreover, the other trades — such as the 8.50/7 spread — suffer a significant erosion of safety relative to the breakeven price. For example, the 8.50/7 spread is mathematically unfavorable since the yield only rises to 27.12%, while the gap to breakeven slips from 12.22% (for the 8/7.50 spread) to 9.11%.
From a pure gambling perspective, the 8.50/8 spread with its yield of nearly 43% is initially enticing. However, the breakeven price for this trade is $8.35, only 7.22% below WBA stock’s Monday closing price of $9.
Sure, the option expires this Friday. But given how much WBA stock can move, I’m not comfortable with a margin to breakeven lower than 10%. Therefore, the 8/7.50 bull put spread would probably be the only one to look at — if you’re looking at this trade at all.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
