One of the most fascinating things to do in option trading is to analyze order flow, and study the malleability of options. As we used to say on the floor, until the day of expiration, a put is a call and a call is a put. This is because of put-call parity and synthetics. Traders can use combinations of options to turn a bearish trade into a bullish trade or a bullish trade into a bearish trade.

Here is an example. Suppose a trader owns 500,000 shares of Apple (NASDAQ: AAPL) from $310 a share. Up nearly $48 a share (about $24 million) and fearful of the recent rumors about Steve Jobs’ health, the trader decides to enter a delta-neutral trade. The trader sells 500,000 AAPL shares at 358.00 then buys 10,000 of the AAPL 365 Calls for 11.15. Let’s look at this from an outsider’s perspective:  you would see a delta-neutral call buy, essentially a straddle. But the hedger sees that, at a cost of $18 a share, he has locked in $30 of profit on his 500,000 shares. And, if AAPL rallies above 365.00 by April — a possibility if the Jobs rumors are false — the trader will actually be long even more stock then he started out with. In fact, if AAPL rallies past 372, the trader will be better off than he or she was before the hedge.

Here is an example of a trade that went up Thursday in Freeport-McMoRan (NYSE: FCX). A trader sold 7,500 of the FCX May and August 57.5 Puts and bought 15,000 of the FCX May and August 50 Puts against the sales. If one only looked at the trade itself, one might see this as a bearish play. After all, FCX got buried on its earnings report in late January and has failed to recover much of what it lost. The stock is hitting lower highs and lower lows … a bad sign for most companies in the short term.  Another bearish sign, FCX implied volatilities are elevated.

However, I have a different take on this trade — I think the trader is long the underlying. My guess is the trader thinks the stock is going to rally, but fears the downside. The trader also does not want to outlay a large amount of cash for the hedge. My guess is the trader has somewhere north of 1,000,000 shares of this company and actually wants to get LONGER at this level.  Part of the 1 X 2 is a put spread – the trader is selling a put spread at a time when implied volatility (IV) is elevated. Something we all like to do. The extra downside put is a protective put. This means the trader is in a position to collect premium and make money if FCX rallies.

I can’t say I do not like the trade, as right now it appears that May is the most overpriced month. The 55 strike, the at-the-money, seems to have the most elevated IV level. An interesting trade would be selling the FCX May 55 Puts and buying the FCX May 50 Puts against it for a net credit of 2.05. Although, as of Thursday’s close, the trade with the most edge in it was actually selling the FCX MAY 55 – 54.5 Put Spread and collecting 30 cents per contract.

Follow Mark Sebastian on Twitter @optionpit.