CSX Options—Bull Risk Reversal


Yesterday, there was a large trade executed in CSX Corporation (CSX) that I want to highlight.

As I noted last Thursday, there's widespread speculation that hedge fund titan Bill Ackman will release the names of two stocks in which he's building large positions. Mondelez International (MDLZ) is speculated to be one of those stocks. Here's what I wrote about the recent option trading in MDLZ last week:

Ackman has used options in the past to build positions. However, if I were to speculate, he likely wouldn't be buying calls slightly out-of-the-money with only a couple of weeks until their expiration. If I were Ackman, I'd be buying in-the-money calls with many months until their expiration. That said, the option activity is certainly suspicious.

CSX is another stock that's widely speculated to be an Ackman target, and yesterday there was a large trade that better fit the profile of a hedge fund putting on a big bullish position than the MDLZ trade.  

At noon yesterday, with the stock trading at 34.25, a trader bought 27,600 CSX January 37.5 Calls for $1.30, and sold 27,600 January 31 Puts for $1.50, for a net credit to the trader of $0.20. This is a bull risk reversal, and is one of the most bullish trades that can be made.  

If CSX closes between 31 and 37.5 on January expiration, the trader will collect a premium of $552,000 as both the call and put will expire worthless.

If CSX closes below 31 on January expiration, the trader may be forced to buy 2,760,000 shares of CSX at 31. This would be a capital outlay of $85,560,000.

If CSX closes above 37.5 on January expiration, the trader has the right to buy 2,760,000 shares of CSX at 37.5, or he could simply sell out his calls for a profit.  

I really like bull risk reversals because the sale of the put lowers the cost of the call, and makes the trade "cheap." That's why bull risk reversals are the trade of choice for hedge funds that want to put on huge bullish positions these days. However, the trades are extremely bullish, and if the trade goes wrong, it can go bad in a big way. Also, the trades require a large cash position in your account to cover the stock you may be forced to buy if the put goes in-the-money.

It will be interesting to see how this trade plays out. Bullish activity in CSX has been constant over the last month, and 68,000 June 36 Calls are sitting in open interest. Despite this bullish order flow, I haven't yet executed a bullish trade in CSX because the stock, like many of the transports, has been under-performing the market for several months. That said, if bullish order flow continues to build and the stock regains some momentum, it's a prime candidate for a new bullish position.

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