Ever since the Kraft Heinz (KHC) and 3G Capital bid to acquire Unilever (UN) was turned down, traders have been speculating on who will be the next target. Just this morning, two research houses wrote notes weighing in on whether General Mills (GIS), Kellogg (K), Colgate Palmolive (CL), Coca-Cola (KO) and others would be bought. And late yesterday afternoon, options traders aggressively bought Kimberly Clark (KMB) calls, likely playing a potential takeover. Here were those trades:
Buyer of 5,000 Kimberly Clark (KMB) July 145 Calls for $1.45 – Stock at 133.50
Buyer of 8,000 Kimberly Clark (KMB) July 150 Calls for $1.30 – Stock at 133.75
What was so interesting about these trades was the way that the volatility/price skyrocketed when the trader started buying the July 150 Calls.
As I’ve written about before, volatility is a key component to the pricing of an option, and can be thought of in terms of supply and demand. If a big drug announcement or earnings are coming, traders buy options to protect themselves. Thus when traders are buying lots of calls/puts, the volatility/price of options moves higher.
For example, back when I was a market maker on the Chicago Board of Options Exchange (CBOE), if an order came into my crowd to buy five Google (GOOG) January 840 Calls for $10, I would sell them the five calls at his price and not think much about it because it was an easy order for me to hedge.
However, if a broker like Goldman Sachs wanted to buy 10,000 of the same calls, I wouldn’t sell 10,000 calls at $10. I would likely sell 100 calls at $10, then 500 at $10.50, 1,000 at $11, etc., with the price continuing to move up until I could fill the order. The volatility/price was going higher.
Let’s take a look at the trades made in KMB yesterday, which does a great job of showing how volatility/price can move explosively higher.
As you can see on the left side of the graphic below, these trades were made between 2:08 and 3:27 yesterday afternoon. Also of note on the right side of the graphic is the price of the stock throughout this timeframe. The stock essentially went up $0.60, which is not enough to move the July 150 Calls much because they are so far out of the money.
What’s so interesting about this graphic is the July 150 Calls, which were initially bought for $0.85, then went to $1.00, $1.30, $1.40, $1.45, and as high as $1.55 with the stock trading in a very tight range. Under “normal” conditions (when there isn’t a buying frenzy), with the stock up $0.60, I would expect those calls to move approximately $0.04—not $0.70!!!!
And what’s interesting today with the stock down $1.50 is that the same calls are still offered at $1.50. Volatility/price has not yet pulled back because traders are still “gun shy” to sell these calls.
We often see this type of volatility move when a stock is perceived to be “in play.” Because the market maker doesn’t want to sell thousands of calls into a takeover, he raises the price/volatility as high as he can so that they’re selling at “good” prices.
We also see this type of volatility movement when traders aggressively buy “weekly” calls, like the Astra Zeneca (AZN) call buyer yesterday. Why? Again the market makers are thinking to themselves, “This is an odd trade. What does the buyer know? And how am I going to hedge this trade?” (It appears the AZN weekly call buyer will lose his premium as the stock is only up $0.15 at 29.75—though he still has the rest of the day until the calls expire).