In tracking Institutional and Unusual Options Activity one of the most important things to do is to look for themes.  Often this is seen sector-based, seeing unusual call activity across a group, often seen in Gold Miners, Airlines, Solar, and Home Construction before the groups make a big multi–month run.

Today a theme was seen in the Oil & Gas Exploration and Production sector with 9 different names seeing large complex option spreads (PXP was late yesterday as the 10th).  All of these spreads involved selling downside puts to buy either calls, vertical call spreads, or ratio call spreads.

All of the spreads were Delta Positive, Gamma Negative, Theta Positive, and Vega Negative.

The trades are structured to take advantage of a slow grind higher, as the upside in the ratio spreads is capped before the spreads start to lose money, and lower volatility and the decay with time work to these spreads advantage.

All of the spreads also traded with a large block of stock, and my view is that these spreads are being used as stock replacement strategies, selling puts at a level that is a value you are willing to be long the stock again, while also owning upside exposure for a move higher, the best case scenario being a move higher in which the puts expire worthless and the call spreads have value.

Many of these companies have substantial exposure to Natural Gas, so these positions are effectively calling a bottom as companies cut production to stabilize prices, but also realizing prices have modest upside potential.  M&A could also provide a lift to this group with Foreign Oil very interested in acquiring US Shale Assets and many of these names trading near multi-year lows.

Chesapeake Energy (CHK) could be a name to attract M&A interest, a name that has seen 50,000 January 2013 $35/$45 far OTM call spreads bought at $0.35 to open in the past week.

I prepared an Excel sheet detailing each of the trade, and also one detailing some of the key stats for the names involved in these trades.

Trade Details

The P/L Charts for Each of the Trades:

NFX

XEC

SU

DVN

CRZO

COG

WLL

EOG

PXP

DNR

I personally like CRZO, DVN, and XEC at these levels.  If concerned with ratio spreads for margin purposes, butterfly spreads are another way to play an upside grind in these calls.  A safer route is to utilize bull put spreads in these names, and some may wish to sell puts outright, willing to be long stock, following the Smart Money.

Many ways to trade based off this “intel”, hope it helps you make some money!

Late Addition:

Pioneer Natural Resources (PXD) with a seller of 2,500 March $90 puts to buy 2,500 March $105/$115 call spreads for a net $0.40 credit, similar to what was seen in the other names.

Netflix (NFLX) will report earnings January 25th, 2012 after the close, and Street estimates range from $0.40 EPS to $0.70 EPS with $0.55 the consensus, while Revenues have an $816.6M to $894.6M range with $857.6M the consensus.

Netflix faces a lot of scrutiny into earnings with rising content costs, increased competition, declining customer satisfaction, and weaker subscriber growth numbers, while International expansion is a positive.  The $5.55B Company now trades 22.8X trailing earnings, 1.14 PEG, 1.9X sales and 27.75X cash flow, but expects a 97.3% cut to EPS for FY12, just $0.11.

Analysts are active on both side, Northland Capital noting margin compression and a $50 target in a report today and Wedbush also reiterating Underperform with a $45 Target.  Caris reiterated a Sell last week and $59 target, while B.Riley was positive and raised its target to $125.  Piper reiterated overweight this morning calling 2012 a transition year and has a $100 target for shares.  I have posted a couple reports below:

Netflix shares have fallen sharply each of the last 3 reports, and a 6 quarter average max earnings move of around 17%, although skewed by the 37.5% fall last report, so closer to 13% on average.  The January weekly options are currently pricing in around a 13% move on earnings with January IV at 153%, February at 88.6% and March at 77.17%.

On the NYSE today at 2:57pm, 2,150 NFLX February $97.50 straddles trades at $18.10 to open into earnings, and although the $97.50 calls traded at $7.80 with a $7.55-$7.85 bid-ask and the $97.50 puts traded at $10.30 with a $10.20-$10.40 bid-ask, the position looks to have been initiated as a straddle sale judging from the IV movement.

At 2:55pm the February IV was running at 91.1% and after the trades went through at 3pm February IV has plummeted to 83%, a major intraday IV move in the February contracts that makes me believe this was an opening straddle sale.  A graphical display is below (chart via LiveVol)

This was a $3,891,000 trade that was not tied to stock, and is expecting Netflix shares to stay in the range of $79.40 to $115.60 come February expiration.  It is also making a call that IV is too high into earnings.  Note that being short the straddle into earnings for NFLX was very profitable the prior two quarters before last.

The current IV30 to HV30 ratio is 85%/74%, so just 16.2% higher implied to historical.  Into last quarter this ratio was 87%/86%, the prior 55.4%/37.7% (47.7%higher), and the prior 54.5%/36.4% (49.45% higher).  Based on previous quarters this ratio is more similar to last quarter which would favor being long the straddle into earnings.

Let’s look at the chart to see the range this large money trade expects shares to stay within through February expiration, highlighted in yellow below.  The expectation is that the upside is limited to a gap fill move from last quarter, while downside is limited to a re-test of the breakout move that began on 1/4/12, feeling buyers will step in at that level on weakness.

There are many ways to trade this into earnings, but knowing how the large money is positioned generally influences the way I trade the names.  Knowing this info you could also structure a January/March double calendar at the $115/$80 strikes, or sell an Iron Condor in the February options.

A final note is that more than 10,000 March $100 calls remain in Open Interest, bought on January 4th when this rally in shares began at $2.65 to open, and tweeted to the public, calls that recently hit as high as $15.  The calls are currently at $8.55 and the buyer is holding steady, and will be interesting to see if the position closes into earnings.  The January $105 weekly calls were actively bought today with 4,400 trading as well.

With that in mind it gives a bullish bias on price and a bearish bias in volatility, making the February $105/$120 1X2 Call Spread at around a $1 debit a very interesting bullish trade with a potential high reward (Profit Zone = $106 to $134)

Equinix (EQIX) is one of the nicer weekly charts right now, especially in Tech, as it has outperformed its peers by a wide margin to start 2012.

I have been tracking this one closely because back on May 5th 2011 with shares at $99 a January $110/$130/$145 Butterfly Call Spread traded 9,400X18,800 contracts at a debit of $3.80, currently worth around $4.

With one week until expiration we could see the owner roll this trade out a few months, cash out, or take deliver of shares via the long $110 calls, but it would be quite suspicious if something goes down this week, say a takeover.

The $5.34B data-center Co. trades 42X earnings, 3.5X sales, and 2.64X book, but a strong 40.85% EPS growth outlook, and demand is on the upswing.  Earnings are not until February options expiration.

However, with IBM and F-5 (FFIV) set to report this week, we could see some kind of deal spark shares higher, just a guess.

Either way, it will be interesting to see how this $3.572 million trade goes down…

If you are unaware by now, the solar stocks,and particularly the Chinese solar stocks rallied today on massive stock volume.

What you may not be aware of is that option traders were buying calls in these names right off the opening bell, and call volume and volatility soared, to the point that by 2:30pm most of these positions were up 100% intraday and positions were being rolled up to further out of the money strikes.  I tweeted out the activity very early in the day, and provided the in depth analysis in the live chat to subscribers.

Also, this was Institutional buying, big lots of 2,500+ contracts changing hands, aggressive bullish buys on the offer.

The next question is the why?  Well there are many reasons floating around, but the main reason that is not being talked about is that on February 13th, 2012 the Department of Commerce will make a decision on whether or not to have additional tariffs on Chinese imports of Solar Cells/Equipment.

More Details at Business Week – Bloomberg

Some other reasons being tossed around are a call by Deutsche Bank that the names are oversold, and just a good old fashioned short squeeze in names that are trading at historically low valuations and although many will not survive due to debt burdens, the upside potential brings in the option traders, and the potential for a lot of near term volatility.

I put together a chart of the action and some other stats for these names with today’s trading, wild action for sure and a lot of money to be made scalping these calls intraday:

OCZ Tech (OCZ) will report results on 1/9/12 after the close, and shares have gapped higher each of the last two reports.  It actually posted a 0.03 Loss vs. an Expected 0.03 Gain last report, but FY12 guidance was near the high end.

OCZ is a leading player in solid state drives (SSD) that are replacing hard drives as faster, more reliable, cooler, and utilize less power.

OCZ Tech trades 13.6X earnings, 1.46X sales, 2.9X book and projects $0.56 in earnings next year, after losing $0.70 EPS the last twelve months.  There is a 44.3% short float in shares, 13.85 days to cover.

FBN raised its target to $11 on 12-1, after the Company pre-announced Q3 revenues to be $100-$105M, ahead of $89.4M consensus.

OCZ announced a distribution deal for Ingram Micro (IM) today that boosted shares 7%, also lifted by strong SeaGate (STX) guidance.

On January 5th, 2012 OCZ traded 2,684 calls, more than 2X daily average with 66% of the action bought on the offer, strong bullish action.  Front month, January, IV jumped 18.5 points to 104.07%, which compares to February at 89%.  Traders were actively buying January $7 and $8 calls with 1,082 and 1,176 trading respectively.  The IV Skew shows a strong demand for OTM calls in both January and February, a bullish skew.

The chart sets up great, shares breaking out past trend resistance of a triangle pattern today, major support near $6.50 where there was a Golden Cross of the 50/200 day EMAs, while the 50/200 SMA bullish cross just occurred this week.  Looking at the chart, there is really nothing stopping OCZ from a move back to $10, especially with the short squeeze factor.  The shares also triggered bullish MACD and ADX crossover signals today.

OCZ looks like a great play into earnings, following the hot action, the Jan. 8 calls look attractive at $0.45, note that an earnings directional play is speculative, and willing to lose the full position, but you can get an edge if you do an in depth analysis from every perspective.

Another way to play the volatility is the January/March $9 Calendar Call Spread at $0.40 to $0.45

I have been watching a lot of size trade in Apollo Group (APOL) options recently, and most of the trades have been collars, or other stock-tied trades, so it is tough to take a directional approach into results, but wanted to lay out the full view into earnings.

Apollo is a $6.95B leader in online education and training, and very quietly this much scrutinized industry due to accreditation has traded fairly strong in all tapes.  Apollo trades 15X forward earnings, 1.47X sales, and 9.44X cash flow, cheap on a cash flow basis, but only seeing 5% EPS growth in FY12, so nothing fantastic.  The short float has come down dramatically, now just 8.75% of the float, or 5.44 days to cover.  There has not been a lot of sell-side coverage, on October 20th Wunderlich upgraded shares to Buy with a $63 target, citing the move to a higher quality of enrollment will see earnings growth follow.  Apollo made a $1.4B acquisition of Taminco in December.

The chart is also an interesting view, shares recently with a key breakout above $52 longer term resistance, and now flagging ahead of earnings.  Shares also broke above its 200 week EMA recently and past a trend resistance off the highs going back to 2009 all time highs.  The measured move on the ascending triangle breakout at $52 is to around $70, so overall the chart is bullish in my opinion.

Earnings will be reported 1/5/12 after the close, and Analysts expect $1.18 EPS and $1.16B in revenues.  APOL has beaten EPS expectations each of the last 4 quarters, and shares have average a 14% move in the last 5 reports, 3 times trading higher and twice lower (Max Moves +14.77% and -26.4%).

Apollo January IV stands at 57.1% and February at 46%, a fairly normal skew structure.

Institutional Option Traders have been very active in this name for months, a few of the large trade include:

10/19: Trader Buys 5,000 Jan. 55 Calls $1 and Sells 5,000 Jan. 38 Puts $1.25 – Collar on Short Stock

11/18: Trader Sells 5,000 January $48 Calls, and Sells 2,000 January $36 Puts

11/21: Trader Buys 7,400 January $36 Puts at $0.73 with Long Stock

12/13: 4,500 February $55/$45 Collar on Stock (Sold Calls, Bought Puts at $0.16)

12/28: Buyers active in January $55 Puts ITM (2,360X) and $50 Puts (1,970X)

12/30: Buyer of 5,000 January $60 calls, Sells 10,000 January $48 Puts – Collar on Stock

1/3: Trader Buys Back 5,000 January $55 Short Calls, and Opens 5,000 May $60/$40 Collars on Stock

I really have not put too much thought into ways to trade this one into earnings because the action has been so scattered, and stock-tied trades make it tougher to get a directional read.

Trade Idea 1: The January $55/$50 Strangle at $3.20 Feels “Cheap” Considering Historical Earnings Moves

Trade Idea 2: Buy the January $55/$60 Call Spread at $1.30 – Bullish Trade

Trade Idea 3: Buy the January $55/$50/$45 Put Butterfly Spread at $1.15 – Bearish Trade

My gut says to lean bullish based on chart, fundamentals, and overall feel that traders are getting long stock and collaring with options.

I have always had a good eye for buyout targets and have been long call options in quite a few takeovers the past 2 years.  Obviously there is no exact science here, and it is difficult to predict, as seen when I looked back at Goldman, CSFB, and UBS’ M&A targets for 2011 and each only got about 1 of 35 picks.

To keep this simple I will look at each sector, and pick companies that are less than $15B in market cap, either a value name or earnings momentum, and some other criteria I will keep private.  Also, I will take into account names where I have seen unusual options positioning, as this has been my top indicator ahead of takeovers, and I will try and add some names to the list throughout the year based on the action I see in that market.

Basic Materials (I believe this will be the hot spot for deals in 2012)

1. Weatherford International (WFT) – Option traders have been actively positioning in call options in February, May, and January 2013 contracts, a ton of bullish positioning.  The $11B market cap makes for a large deal, but it is one of the smaller Oil Services names remaining, and cheap at 9.6X earnings with strong growth prospects.
2. Cliffs Natural (CLF) – A leading Iron Ore producer and prices are stabilizing as Steel companies increase production.  Shares are too cheap at 5.1X earnings, 1.56X book, and 5.8X free cash flow.  The $8.9B market cap is small enough for a large Steel Co. to acquire and integrate to save costs.
3. Walter Energy (WLT) – The $3.78B metallurgical coal Co. has long been rumored to be a takeover target and 2012 is the year a deal will happen.  The Company owns some of the most quality assets in the industry and at 7.26X earnings, 1.66X sales and 1.8X book, the value is clear.
4. Rockwood Holdings (ROC) – The $3B chemicals Co. trades 9.4X earnings, 0.42 PEG, 0.83X sales and 2.2X book value, and a history of strong earnings.  Chemical stocks have been beaten down and a lot of value names in this group that was fairly hot for M&A the past two years, so I expect more deals to come.
5. Huntsman (HUN) – Another chemical Co. with a $2.38B market cap, and trading 5.2X earnings, 0.22X sales and 1.3X book.  Also, a name seeing bullish call buying in January and February strikes.  Huntsman has lacked operational performance, but a buyer could turn this into a profitable deal.
6. Steel Dynamics (STLD) – There is sure to be a deal in Steel in 2012 and although AK Steel (AKS) and US Steel (X) are often mentioned in chatter, Steel Dynamics makes more sense, a $2.88B market cap trading 8.8X earnings, 0.38X sales, and 1.25X book with a better growth outlook.
7. CF Industries (CF) – CF Industries is a $9.5B Co. and smaller than most of its fertilizer counterparts, and although seeing minimal growth for 2012, it is a value at 6.5X earnings and 4.26X free cash flow, also more of a niche play for Nitrogen.  BHP failed to acquire Potash (POT), but I expect that there will be a lot of interested buyers in the Ag space for 2012 with global miners looking to diversify portfolios.