Heavy Option Volume in Yahoo!

With a week-and-a-half to go before its earnings report, Yahoo! (NASDAQ: YHOO) saw what appeared to be a large risk-reversal trade cross the tape last Thursday. In early activity, a block of 30,000 April 19 calls traded for the bid price of 44 cents while a block of 30,000 April 15 puts changed hands for 40 cents (the ask price at the time). It looks like the calls were sold while the puts were bought, for a net credit of four cents per share.

This strategy is known as a risk reversal or a synthetic short stock, as the short call and long put together have a similar profit/loss profile as a short stock.  Generally, risk reversals will appreciate in value if the stock declines and lose value if the underlying stock rallies.

In this case, however, the same investor appears to have hedged by buying roughly 1.4 million shares of YHOO for $16.65 per share.  Had the trader bought 100 YHOO shares for every risk reversal traded, this would look like a collar strategy but as it stands, it was a delta neutral trade.  This becomes a volatility trade as opposed to a directional one.

As we like to point out traders sometimes take on the delta risk themselves to potentially help speed their execution and improve their fill price. This is especially true if they are trading on a large scale.  Once filled, the traders can sell back the stock, leaving the risk reversal open.

The profit/loss calculator shows this risk/reversal play at expiration, assuming the stock position is in fact sold to close. Between the strike prices, gains are limited to the modest four-cent credit. Below the 15 strike, gains begin to build down to the zero mark (so are technically capped at $15.04). Above the $19.04 breakeven level, losses are unlimited as the stock moves higher.