TRADE OF THE DAY: BUYING PROTECTION

Investors are protecting themselves from potential downside in emerging markets and the bloated pig that is AIG:

AIG – American International Group, Inc. – The wings of a butterfly spread unfurled across the October contract this morning as one option trader appears to be loading up on protective put options. Shares of the insurer had surged as much as 15% to $54.91 today, but is currently up by a more modest 6% to $50.72. It is likely that the investor initiating the butterfly strategy is currently long shares of the underlying stock and is aiming to cheapen the cost of protecting his stock position. The body of the butterfly landed at the October 35 strike price where 10,000 puts were shed for 3.10 apiece. The sale of the central strike puts partially offset the cost of buying both the wings. The higher October 45 strike price had 5,000 puts bought for 6.90 each, while 5,000 puts at the lower October 25 strike cost him 1.10 apiece. The net cost, and incidentally the maximum possible loss on the transaction, amounts to just 1.80 per contract. This trader has built up a buffer against declines in AIG through expiration in October. Downside protection kicks in beneath the breakeven price of $43.20 and accumulates to a maximum of 8.20 realized if shares fall down to the central strike price of $35.00. Of course, it is always possible that the investor does not hold shares of the underlying. If this is the case, he is taking an extremely bearish position on AIG and hoping to amass maximum profits of 8.20 per contract on a more than 31% decline in the stock to $35.00.

EEM – iShares MSCI Emerging Markets Index ETF – Shares of the emerging markets fund are slightly lower today by less than 1% to stand at $35.97. Some investors were seen hoarding put options on the ETF, but mere put volume does not necessarily mean traders are bracing for bearish movement in the price of the underlying. Put-buyers could be long the stock and seeking downside protection, or they may expect to profit from declines if they are short the stock. The nearer-term October 34 strike price had 20,000 puts picked up for an average premium of 98 cents per contract. Shares of the EEM would need to fall about 8% from the current price before put-holders breakeven at a price of $33.02. Longer-term put action was observed at the just in-the-money January 36 strike where 18,615 puts were purchased for an average premium of 3.35 each. If this trader is long the stock, downside protection begins to accumulate if shares fall beneath $32.65 by expiration next year.

Source: IB Options Desk