In this morning’s Watch List, I noted a trade in Agilent (A). I’ve been watching this stock for months as a large trader has been building a significant position, mainly through Bull Risk Reversals. Here are the details of yesterday’s trade:
Buyer of 3,000 Agilent (A) February 42.5/37.5 Bull Risk Reversal (repeated buyer of this very bullish spread)
In a Bull Risk Reversal, the investor buys the call and sells the put. It’s an ultra-bullish position as buying a call is a bullish position, and so is selling a put. With the stock trading at 40, this trader bought the February 42.5 Call for $1.34 and sold the February 37.5 Put for $1.20, for a total capital outlay of $0.14, or $42,000.
Here is a graph of the profit/loss of the position at February expiration:
As the graph shows, this is an extremely risky trade if it goes wrong because if Agilent closes below 37.5 on February expiration, the trader will take delivery of 300,000 shares of stock. The trader may be willing to own that much stock at that price, and that’s why he chose to sell those puts.
To the upside, this trader will be long 300,000 shares if the stock closes above 42.5 on February expiration.
If the stock stays between 37.50 and 42.50 on February expiration, the trader will lose his $42,000 investment in the spread.
Risk reversals are a favorite trade for many top hedge funds as the capital outlay is quite limited with the sale of the put. For example, in this trade, if the trader simply bought the February 42.5 call 3,000 times for $1.34, his capital outlay would be $402,000. However, by selling the 37.5 put, he has lowered his cost to $42,000.
As of the close of trade yesterday, this trader (or traders) owns 40,000 February 42.5 Calls and 50,000 February 45 Calls, and is short 17,000 February 37.5 Puts
This kind of continued bullish activity has made Agilent a top target for new bullish trades. However, the company will present at the J.P. Morgan Healthcare Conference on Tuesday January 13, and because of this event, if we enter into a trade, it will be high risk.