Large trader footprints?

On Friday, software company Atlassian (TEAM) dropped 29% to $123.73 after releasing earnings and lowering its guidance.¹ As one would expect, put volume was elevated, running around 14 times average, with the biggest position (7,400 contracts) appearing in the January $115 puts.

There was a tie for biggest position, though, because there was also a 7,400-contract trade in the January $115 calls. Same-sized call and put positions with identical strike prices and expirations could mean a large trader put on a “straddle,” a non-directional trade designed to (whether the trader is long or short) take advantage of an increase or decrease in volatility.

Consider the risk-reward profile for a long at-the-money straddle, where the options’ strike price is at or near the current stock price:

The long straddle is a “long volatility” trade. It may be neutral about the direction the stock moves, but not about how much it moves: To be profitable at expiration, the stock has to be above or below the strike price by at least the amount of the combined cost of the options (the “debit”), which in this case was $30.75.

The short straddle inverts the trade premise and the risk-reward profile:

The short straddle is a “short volatility” trade: It can profit if the stock moves up or down, as long as it doesn’t move too much. Its maximum profit occurs if the stock is at the strike price at expiration, in which case both options expire worthless and the trader keeps all the premium collected from selling the options (the “credit”). The position can generate at least some profit if the stock price is no more than the amount of the credit above or below the strike price.

For the sake of argument, let’s say one large trader was responsible for initiating a 7,400-contract straddle in the January $115 options—a position with a total value at Friday’s close of $22,755,000. How do we know if it was a long straddle or short straddle? We don’t. But TEAM’s recent situation offers some food for thought.

First, it’s not just the stock’s volatility that matters. The bottom of TEAM’s price chart shows that, in addition to the surge in historical volatility (HV) on Friday, options implied volatility (IV) was just a little below its May–June highs, which were the highest levels since July 2020:

Because high IV often inflates options premiums, many traders like to sell high-IV options, regardless of their outlook on the underlying stock—and specifically if they have a neutral outlook. That means a trader may have felt TEAM’s options were somewhat overpriced.

IV often drops after a company releases earnings, although how much and how fast varies from case to case. One indication that TEAM’s options may have been relatively inflated by high IV on Friday was how much value the January $115 straddle lost on Monday. Around 12:15 p.m. ET, the position was trading for roughly $27.55—$3.10 (10.4%) lower than at Friday’s close—even though the stock had made a significant (-7%) price move.

Monday’s early sell-off, coincidentally, dropped shares very close to $115, the options’ strike price.

Market Mover Update: Stocks started off midterm election week the way they usually have over the past 10 election cycles—with a solid gain.

Last week’s semiconductor earnings were mostly underwhelming, but Morgan Stanley & Co. analysts see potential for a turnaround in at least one area—European chip stocks, including ASML (ASML) and BE Semiconductor (BESIY).²

Today’s numbers include (all times ET): NFIB Small Business Optimism Index (6 a.m.), midterm elections.

Today’s earnings include: Occidental Petroleum (OXY), Disney (DIS), Upstart (UPST), Lemonade (LMND), Silk Road Medical (SILK), Plug Power (PLUG).

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¹ StreetInsider.com. Atlassian (TEAM) Misses Q1 EPS by 4c, Guidance Falls Short of View. 11/3/22.
² MorganStanley.com. Nearing the Bottom. 11/7/22.