Market Insights

Last quarter iconic sneaker maker Nike (NKE) surprised to the upside. One big options trader seem to expect more good news  tomorrow night.

Here’s a breakdown of the complex, high-risk complex strategy that appeared yesterday afternoon:

• 4,100 6-July 73.50 calls were bought for $1.77.
• 4,100 29-June 68 puts were sold for $0.40.
• 4,100 29-June 77.50 calls were sold for $0.33.
• That translates into a $1.04 net cost.

Three different contracts expiring in two different weeks?!? What’s going on?

First, owning calls fixes the price where a security can be purchased. They can leverage a rally when shares rally. This is the “long side” of the trade.

Second, selling options generates income. The short puts create an obligation to buy NKE if it’s under $68 on Friday while the short calls force the investor to deliver shares for $77.50 if they’re over that price. (Remember, selling puts carries significant risk and may not be suitable for all investors. Make sure to visit our Knowledge Center for more.) It’s essentially a “diagonal spread” plus short puts.

Third, a little thing called “implied volatility.” That’s the premium the market charges for an option, essentially the price of controlling movement over a certain time frame. Implied “vol” tends to be higher before big events like earnings, but then evaporate after the news. That’s probably why the trader sold the contracts expiring this week, while buying the contracts expiring next week!

NKE rose 0.30 percent to $72.57. The last earnings report on March 22 showed direct sales to customers surprising to the upside, plus traction for newer products. That warmed the hearts of investors accustomed to falling sales.

Now with the next set of numbers due Thursday afternoon, here’s how Tuesday’s options strategy could play out:

• If NKE ends the current week above $77.50 they’ll be forced out of the position in return for $4. That would be a profit of about 280 percent.
• If the shares remain between $68 and $77.50, they’ll simply hold the 72.50s, with potential to make or lose money depending how the company trades next week.
• If it drops below $68, they’ll essentially lose money on a dollar-for-dollar basis below that level.

In conclusion, this trade is great to learn from because it shows how options veterans can exploit different rates of time decay at different expiration dates in the options market.