Second surge short-circuits short trade

  • JANX rallied more than 57% in three days last week
  • A chance for contrarians to sell overpriced call options?

Because market overreactions are often prone to countermoves, some traders look to sell options when a stock makes an exaggerated move, up or down. For example, a sharp sell-off on unexpected news may push up the price of put options—sometimes dramatically. Traders who think the stock is unlikely to move much lower, or even rebound, may choose to short puts, which will lose value not only if the stock rallies, but also because of time decay.

The same goes for a stock that makes a big up move. Consider what a trader may have done when Medpace (MEDP) rallied 20% (to $272.27) on October 24 after releasing earnings:

Chart 1: Medpace (MEDP), 9/12/23–11/17/23. Medpace (MEDP) price chart. Collecting premium on stock rally.

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

Let’s say the trader thought MEDP was unlikely to rally above $290 over the next few weeks, since there were no obvious “good news” catalysts on the horizon. The trader may have decided to short the out-of-the-money (OTM) November $290 calls, which were trading around 1.55 ($155). As long as the stock was below $290 in a little more than three weeks, the options would expire worthless and the trader would get to keep the collected premium.

In this case the trader was right, even though the MEDP ultimately kept rallying. The stock pulled back sharply for a few days after the October 24 rally, then climbed close to $290 before closing below $280 at expiration on November 17.

Some traders may have been thinking along the same lines last week as Janux Therapeutics (JANX) rallied 57.5% over the course of three days (February 21-23):

Chart 2: Janux Therapeutics (JANX), 11/9/23–2/23/24. Janux Therapeutics (JANX) price chart. Three-day surge.

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

Given that was JANX’s biggest three-day move in its history—pushing the stock to its highest close ($15.69) in more than a year—some traders may have seen an opportunity to short OTM calls in expectation of a pullback, or at least slowing upside momentum. On February 23, the April $20 call closed at 3.20, up from 2.00 a day earlier.

On Monday, it probably looked like a good trade. The stock fell 3.8% and the April $20 call lost about a third of its value, returning to 2.00. Yesterday, though, the picture changed dramatically:

Chart 3: April WTI crude oil (CLJ4), 9/15/23–2/22/24. Crude oil futures price chart. Resistance at prior highs.

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

Shares of JANX jumped 231% intraday to $50, pushing the April $20 call price to $24.60 ($2,460) by midday—a $2,140 loss per option.

The obvious lesson here is that while big moves often temporarily pull back or reverse, sometimes they don’t—or at least not in time, or not enough, to save an options trade. But the JANX example underscores a second, more practical point: the importance of staying on top of any and all potential catalysts (especially in the biotech arena). In this case, JANX had publicly announced it would release clinical test results on its prostate cancer therapy this week.

While traders may not have expected the stock to more than triple intraday on Tuesday, the imminent release of clinical trial results would have been a good reason for traders interested in shorting calls last week to exercise caution.

Market Mover Update: It’s a leap year, and that means Thursday will be February 29 instead of March 1. Although it hasn’t happened that often, when the US stock market has been open for trading on February 29, bulls have more often than not taken the day off: The SPX closed lower on eight of the 13 leap-year February 29s since 1950, but closed higher eight of the 13 times the following day (the first trading day of March). In contrast, the SPX closed higher 53.5% of the time on the first trading day of March when it immediately followed February 28.

Today’s numbers include (all times ET): mortgage applications (7 a.m.), Q4 GDP, second estimate (8:30 a.m.), advance International Trade in Goods (8:30 a.m.), advance retail and wholesale inventories (8:30 a.m.), EIA Petroleum Status Report (10:30 a.m.).

Today’s earnings include: Advance Auto Parts (AAP), B. Riley Financial (RILY), Squarespace (SQSP), TJX (TJX), C3 AI (AI), Salesforce (CRM), Duolingo (DUOL).


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