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There has been a large increase in put options activity in Alphabet stock (GOOG, GOOGL) as seen in the Barchart Unusual Stock Options Activity Report today. It shows that a large number of put options have traded in both stocks for near-term expiration periods and at-the-market strike prices.
The reason this is important is that we can determine that the volume of put options has dwarfed the existing number of options outstanding (i.e., open interest) for these expiration and strike price tranches. That is seen in the Barchart ratio calculated by the Vol/OI ratio.
For example, in all of these tranches, the Vol/OI ratio is well over 20x, indicating that the trading volume in these puts today is 20x+ existing number of contracts. That makes it highly likely that these trades have been initiated by institutional investors, probably long-short funds (i.e., hedge funds).
Analyzing GOOG and GOOGL Put Activity Today
Let's take a look at these trades and see what we can glean from a practical standpoint. To do so, take a look at the options activity screen from the Barchart report which I have highlighted below.
Keep in mind we must make some assumptions, which you may or may not agree with. But the point is to try to mimic what we see hedge funds doing, in order to make money.
Almost all of these expiration periods are for this Friday, two days from now. Next, we can see that the strike prices are $119, $120, and $121 - all very close to today's prices of GOOG stock at $119.78 and GOOGL stock at $119.23.
In fact, the trades are now “in the money” - i.e., the strike prices for the puts are higher than the stock price. This means that unless the stock moves higher, the sellers of these puts will have to purchase the underlying stock at the strike price. That is, this is what will happen if the short sellers do not cover or buy back their short trade position.
However, given the huge volume that these trades represent - over 20 times the existing open interest, it is possible that the long-short funds might have actually initiated these trades as a short position. They may either expect GOOG and GOOGL stock to rise, or they believe that the prices of the puts will deteriorate closer to expiration - in which case they can cover their position.
Risky Trade
This is a very risky trade, but it could pay off. For example, the 10,649 GOOG puts that traded at the $120 strike price for $1.10 have a break-even level of $118.90. In other words, if the stock stays where it is today, the intrinsic value of the puts is only 22 cents (i.e., $120 strike price - $119.78 GOOG price today).
This means there is $0.88 of extrinsic value that could be reaped as profit (i.e., $1.10 premium received less 22 cents intrinsic value). That potentially means the fund(s) that shorted 10,000 of these puts can make $880K in just 2 days (i.e., $0.88 x 10,000 x 100).
Granted, though, they would have had to risk $120 million in cash and/or margin to do that trade (i.e., $120 strike price x 10,000 contracts x 100 shares/contract). And GOOG stock has to stay where it is. But that works out to a 0.733% profit return in 2 days (i.e., $0.88 mil/$120 mil), or less than 1%.
But if the long-short fund has the ability to do this 4 times a month with each weekly options expiration period, the overall return is 2.9% per month or 35.2% if repeated for 12 months. That is a pretty good return, especially since the fund can also hedge its bet on the trade.
One way, for example, would be to accept the inevitability that sometimes the fund will have to purchase the puts at $120, with an ensuing unrealized capital loss. Nevertheless, the fund can then turn around short out-of-the-money calls to make up for some of the potential unrealized loss in the position.
Keep in mind that some of the trades could have been initiated as long puts. In that case, the investor is hoping that GOOG stock falls below $118.90 before the intrinsic value of the puts is above the $1.10 that was paid. This is a riskier trade however than the short put initiated trade.
The bottom line here is that if you believe that GOOG stock will not fall dramatically between now and Friday, it might make sense, if you can withstand the risk, to copy these trades in GOOG and GOOGL puts.
On the date of publication, Mark R. Hake, CFA 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.
