Tech bulls widen horizons as sun sets on strong quarter

Is the Tech sector due for a slowdown after a runaway rally in Q1? Option traders don’t appear to think so.

Much attention has focused on high-profile leaders like Apple (NASDAQ: AAPL) and Facebook (NASDAQ: FB), which have hit new record highs several times in March. This week’s option activity shows buyers widening their horizons and looking for smaller names to advance into the summer.

Take Yelp (NASDAQ: YELP). The provider of online reviews cratered in February on weak guidance, but has held longer-term lows around $32. On Wednesday traders positioned for the stock to recover that entire selloff by purchasing 4,000 August 38 calls for $1.75 and selling an equal number of August 43 calls for $1.

Known as a vertical spread, the strategy cost $0.75 up front per contract, and carries a potential return of over 500 percent should the stock move back up.  Here’s how it works:

  • Long calls fix the price where a security can be bought, so they have a right to buy YELP for $38 if it climbs above that level.
  • Short calls create an obligation to deliver shares if a certain level is reached, so they must sell YELP for $43 if it goes over that level.
  • Altogether they will collect $5 from YELP closing at $43 on expiration, which matches almost exactly its 52-week high of $43.41.
  • That translates into a $5 return ($43 - $38). Divide that by the $0.75 cost and you get profit of 567 percent excluding before commissions and fees. The breakeven is $43.75.

Of course, there is significant risk because if the stock doesn’t climb the entire position will expire worthless. After the call spread was purchased, some 9,000 May 35 calls were also purchased in large blocks for $1.40 and $1.55. The activity pushed overall option volume in the name to more than 10 times the monthly average, with calls outnumbering puts by more than 50 to 1. YELP rose 3.05 percent to $32.78 at yesterday’s close.

Yelp (YELP) 6-month chart

Source: OptionsHouse by ETRADE

Chinese social-media stock Weibo (NASDAQ: WB) is already up more than 180 percent in the last year. Yesterday traders rolled a position in the 31-March 52 calls (expiring tomorrow) into the April 52s. They paid a net cost of about $1.20 per contract and have an additional three weeks to profit from a potential rally. WB rose 3.88 percent to $53.61.

Call buying isn’t the only way to get bullish with options. Traders can also sell puts, essentially collecting money now in hope a stock will remain above a certain level. That happened in software developer Cognizant Technology (NASDAQ: CTSH) on Monday, when 5,000 May 55 puts were sold for $1. The premium will be retained as profit if the shares stay above $55 through expiration, but there can be painful (Read: unlimited) losses if it doesn’t. CTSH closed up 0.07 percent to $59.08.

In summary, technology has been the best sector in the S&P 500 since the year began, and options traders look like they’re keeping the faith.

Please note: This commentary does not include commissions in its calculations.  Active trader (30+ trades per quarter) commissions for E*TRADE are $4.95 per trade + $.50 per options contract.