Finding the options that matter

  • PZZA rallied nearly 3% on heavy options volume Tuesday
  • More puts than calls, but possible spread may have used both
  • Trades concentrated in October monthly options

On Tuesday, restaurant chain Papa John’s (PZZA) appeared on several LiveAction scans for unusual options activity, with total options volume nearly 43 times average. As the stock climbed its way to a 2.9% gain, call volume was more than 16 times average. But put volume was even more robust—nearly 60 times average.

Unusually heavy call volume, even heavier put volume—what were traders up to?

That’s always a difficult question to answer, but comparing volume to open interest (OI) is a good place to start.

The top portion of the options chain below shows heavy volume in two PZZA October options on Tuesday—1,200 contracts in the $75 puts and 3,000 contracts in the $77.50 puts (the stock’s range was $74.30–$76.02). But the middle portion shows 3,000 of the November $72.50 puts also traded:

Chart 1: Papa John’s (PZZA) options, 10/4/22. Papa John’s options chain. Tuesday’s big options trades.

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)

Since the OI in the October $77.50 put was 3,100 (more than the volume) while the OI in the November $72.50 was only 22 (less than the volume), there was a chance these trades represented someone “rolling” a position—specifically, closing out a 3,000-contract position in the October $77.50 puts and re-establishing it in the November $72.50 puts. In other words, this could have been a position adjustment, not an influx of new put positions.

That may make the bottom portion of the options chain more important, since it shows 1,200 of the October $75 calls also traded, matching the volume in the October $75 puts. And because the OI in both contracts was less than the volume, it means at least some—and potentially all—of Tuesday’s activity represented new positions.

Now, take a look at the various OI totals as of Wednesday:

1. October $75 calls: 1,400 (higher—new positions were opened)
2. October $75 puts: 1,200 (higher—new positions were opened)
3. October $77.50 puts: 498 (lower—existing positions were closed)
4. November $72.50 puts: 3,000 (higher—new positions were opened)

That suggests Tuesday’s big put trades could have been a 3,000-contract rollover from October to November, while the same-size trades in the October $75 options represented new positions—possibly a 1,200-contract long “straddle” that combined the options:

Chart 2: Long straddle risk–reward profile. Options spread strategies. “Long volatility” strategy.

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)

As noted in S&P range highlights “strangle hurdle,” straddles and strangles are volatility trades, not price trades: Their success depends on whether volatility—not the underlying stock price—moves in the expected direction. For a long straddle, that means volatility needs to rise. The position can make money regardless of whether the underlying stock moves higher or lower, with the caveat that it has to move far enough to offset the cost of the options. Also, it has to do it sooner rather than later, since the longer it takes, the more value both options will lose because of time decay.

All these factors suggest that if yesterday’s volume in the October $75 options was, in fact, a long straddle, the trader in question was expecting the stock to move more than roughly $6.20 (the approximate cost of the combined options at Tuesday’s close) above or below $75 no later than October 21:

Chart 3: Papa John’s (PZZA), 4/19/22–10/5/22. Papa John’s (PZZA) price chart. Straddle breakeven levels.

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)

That window of opportunity is especially interesting, since PZZA is currently scheduled to release earnings in the first week of November. Implied volatility (IV) often climbs in the runup to earnings because of the uncertainty surrounding these announcements. That can inflate options premiums even more than they would typically be by a price move in the stock—a plus for traders with long options positions.

Of course, if the trader instead sold the October $75 calls and puts as a short straddle, the position could profit if IV declined and the stock price was relatively stable—the maximum profit would occur if the stock closed at the strike price at expiration, in which case the trader would get to keep all the premium collected from selling the options.

In a little more than two weeks, we’ll know which volatility outlook was the correct one.

Today’s numbers include (all times ET): Challenger Job-Cut Report (7:30 a.m.), Weekly Jobless Claims (8:30 a.m.), EIA Natural Gas Report (10:30 a.m.).

Today’s earnings include: Constellation Brands (STZ), Conagra (CAG).


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