Option Trading can Sometimes Provide Insight
Unusual and 'irrational' activity often tips future price action
Precision Castparts (PCP, Financial) had been strengthening late on April 14. It closed at $215.97 on Tuesday after touching north of $217 intraday.
That afternoon surge proved to be a false signal.
Wednesday morning’s pre-announcement of a $363 MM non-recurring (pre-tax) charge and somewhat below expectation earnings saw the stock plunge as low as $203.94 within seconds of the opening.
That buying opportunity didn’t last long. The shares reversed course almost immediately on high volume while headed back to above $211.
4 PM saw PCP close at $208.08 before an after-hours rise to $209.10. It was a wild ride.
What is PCP worth?
History and Warren Buffett’s judgement (Berkshire Hathaway (BRK.A, Financial) owns a nice chunk) say it is more than today’s price. It wouldn’t surprise me to find out soon that Berkshire added to its position on the dip.
The March estimates now appear too high. Keep in mind, though, that PCP traded as high as $272 during 2013, and broached $275 last year on lower than current earnings and on much less than present day book value.
Option traders were making some big bets on a further rebound during the sell-off.
The May 15, 2015, expiration calls at $220 & $230 were both unusually active. Daily contract volume on the lower strike price ran 3889 versus previous open interest of just 133. The final price of $2.30 indicated a huge play on a rebound to north of $223 over the next 29 days.
Break-even on the $230 strike @ $0.60 per share looked for a move to about $231 in order to pay off. That was more of a longshot bet. Once again, the Tax Day volume exceeded the entire previous open interest.
The same sentiment, that Precision Castparts can rise again before very long, was played out in the September, 2015, $250 & $260 call options. More than 3,000 contracts changed hands on the former strike price. That was 931% of the existing open interest going into Wednesday's session.
$260 might have seemed dreamlike with the stock south of $210. That didn’t stop the buyers of 175 contracts from laying out $0.65 per share for the right to buy PCP at $260 over the next 155 days.
Stranger things have happened in the stock market. The day’s action on the more speculative strike was 1650% of the meager open interest when the shares were trading higher.
History says to respect the possibilities when you see options trading which seems to defy logic. Will today’s big volume on out-of-the-money PCP calls prove prophetic? Only time will tell.
Disclosure: Long PCP shares, short PCP puts
