Massive Deep Out of the Money Call Option Transaction

Question

I am relatively new to options, however something has caught my eye. I see this case of a single leg deep out of money HES Aug 10 call option with a very large transaction of 4,373 contracts completed at the Ask price with bid ask spread of 0.10/0.16, underlying is $64 with a strike at $75, on a weekly option set to expire 20 days from now. Prior to today, that particular option/strike had 0 open interest. Below is the time and sales of the transaction:

The overall volume and present open interest for that dated option is:

As well as the general chart, we can see the price in the last year has never breached $75:

I am curious as to the rationale behind an investment such as this, given they stand to lose a potential ~$69,000 on something that looks like a big gamble?

Answer 1

There are people who go to Vegas with more money that you'll make in 10 years. Sometimes they win, sometimes they lose.

A gambler believe that Hess will pop, maybe on earnings, maybe on insider info. If it goes to $80, their 16 cents is worth $5. 31X their money. I don't know who that player was, but it doesn't take many wins to offset losses when the winning bets are 10X or more.

Last April (2017), I made a similar find. NSC, trading at $118, and a player bought a call spread, buying the $150 strike, and selling the $180 for a net $3.50/sh. But, those options were for January 2019. 21 months to go up 50% seemed more reasonable than 17% (more to profit) in 10 days.

I documented that trade in an article Norfolk Southern 2019 Call Spread. To be clear, I can afford the $3500 that bet cost. I'd be happy to 'win' 1 in 3 of such bets. And no, I don't call this investing. In my experience, the toughest thing about options is that you need to be right on the direction, the magnitude, and the timing. There's nothing like a trade where you only get 2 of the 3 right and the options expire worthless. And then a few months later, the price blows through your target.

Answer 2

You are making an assumption that because the transaction took place at the ask price then it is a bullish speculation on the part of the buyer. It's likely so but not necessarily true. Here are some alternate possibilities. I do not mean for them to represent actual or even logical trades but I'm merely attempting to demonstrate that there are other possible strategies at play rather it's simply a long call purchase that is speculating on a massive run up in the stock past $75 (or into the low 70's before expiration).

For the moment, let's put aside the size of the trade and the Open Interest and consider some hypotheticals.

The margin requirement for selling naked options varies from broker to broker. The B/A for the Aug 10th 70 call is $0.42 x $0.49 . Using one broker's online calculator, if you wanted to sell that call naked, the margin requirement would be $700.

1) If one also bought your Aug 10th 75 call for $0.16, this would create a BEARISH vertical spread and the margin would drop to $474 (difference in strikes less the premium received) and one would also have catastrophic protection in place. This is the opposite outlook than your bullish conclusion.

2) Or perhaps the trader also sold a BULLISH deep OTM put spread, creating an Iron Condor. Two credit premiums and you can't be wrong on both sides. He is NEUTRAL with a lot of room on either side of current price to be wrong.

Portfolio margin is a risk-based margin policy that aligns margin requirements with the overall risk of the portfolio. The Options Clearing Corporation utilizes a formula that sets the margin requirement to the maximum hypothetical loss of the portfolio. Standard Reg T margin is 2:1 and portfolio margin can bump that much higher (5:1 or more).

3) Suppose out trader has shorted shares of HES at the current price. His cash requirement to do so is 50% of the share price. But suppose if he buys your $75 put, his margin might be lowered to 15-20% (portfolio margin). He happens to now own catastrophic protection but he is buying those calls for the express purpose of reducing his margin requirement. He is BEARISH.

Now, back to your charts. Let's suppose that you are 100% correct in that someone bought 4,373 (or more) Aug 10th $75 calls at the ask price of 16 cents. Is he making a crazy foolish bet or does he know something? You found a large trade and the question is, "What does that do for your trading decisions?" My answer is nothing.