What’s the Deal With Safeway Options Activity?

by Beth Gaston Moon | April 19, 2012 8:44 am

What’s the Deal With Safeway Options Activity?

3173128472 1422bfda61 300x225 What’s the Deal With Safeway Options Activity?[1]No, this isn’t the beginning of a Seinfeld routine; it’s an actual question. Safeway (NYSE:SWY[2]) options volume has been off-the-charts notable of late, and there’s probably a good reason for it.

Yesterday, Bloomberg noted that short-term, out-of-the-money SWY calls have climbed in price and have been increasingly popular. Last week, call open interest swelled to more than 62,000[3], hitting its highest point since August 2010.

Puts, on the other hand, are being neglected. The put/call volume ratio for the stock currently stands at 0.13, meaning just 13 puts are being traded for every 100 calls. This is just off the reading’s annual low[4] of 0.11.

Implied volatility, which measures what the options-trading crowd expects volatility to be (versus historical, or actual price movement), has been on the rise for both put and call options. Call implied volatility has shot up past 40%, doubling since mid-March and outpacing the historical volatility reading of 30%. Implied volatility for call options is now at its highest point since October. Put options are seeing a similar trend.

One thing to note, however, is that volatility for long-term options is considerably lower. For example, a 5% out-of-the-money (23 strike) call in the May series has an implied volatility (IV) reading of 41%. In the September series, that same-strike option has an IV of 27%. Volatilities become further crushed as the months move forward.

Steve Claussen, chief investment strategist with online brokerage OptionsHouse[5], notes that this backdrop indicates “uncertainty in the near term but a belief that in the longer-term, the volatility is not worth much.”

SWY shares have risen nearly 9% in the past five days, already rewarding investors who bought calls on the equity. This may be igniting a self-perpetuating cycle among short sellers who are heading for the proverbial hills by buying back SWY shares to close their short positions.

SWY is a heavily shorted stock, as short interest represents about one-quarter of the equity’s float (the shares available for public trading). The number of shorted SWY shares has risen from 31 million in mid-November to roughly 65 million now.

The likely reason for all of this — the increased call volume, the growing short interest, the disparity in short-term and long-term volatility — is buyout speculation. Recent moves by the company have experts and investors alike predicting a massive strategic shift for SWY leadership.

Some expect a merger with Kroger (NYSE:KR[6]). Others believe a leveraged buyout could take the company private. Either way, a decision would likely be announced before later-dated options expire (or at least that’s what options traders currently think).

Investors buying calls risk 100% of the premium paid but can enjoy unlimited upside if the underlying stock rallies. The breakeven price for a long call position is the strike price of the call plus the initial debit.

Some of the most popular SWY options in the May and June series are out-of-the-money: the 22, 24, and 25 strikes. These would have been priced relatively low but require more upside in the shares to lift the calls into profitable territory.

As of this writing, Beth Gaston Moon does not own any shares mentioned here. 

Endnotes:
  1. [Image]: http://investorplace.com/wp-content/uploads/2012/04/3173128472_1422bfda61.jpg
  2. SWY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SWY
  3. call open interest swelled to more than 62,000: http://www.bloomberg.com/news/2012-04-18/safeway-options-surge-signals-deal-as-shorts-pounce-real-m-a.html
  4. just off the reading’s annual low: http://www.schaeffersresearch.com/streetools/indicators/equity_volpcratio.aspx?ticker=SWY
  5. OptionsHouse: http://www.optionshouse.com
  6. KR: http://studio-5.financialcontent.com/investplace/quote?Symbol=KR

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