Bullish Buy-Write Option Activity

Ted Williams/Warren Buffett

ON Semiconductor (ONNN)

Bullish Option Activity

The most successful traders don’t consistently get nine or 10 out of 10 trades right. That success rate is only achieved by the Bernie Madoffs.

The most successful traders look for trades in which they believe they have a real edge-and even then only hope to get six or seven out of 10 trades correct. Warren Buffett described this edge when he said, “We try to exert a Ted Williams kind of discipline.”

In case you’re not a baseball fan, Ted Williams is widely regarded as the greatest hitter of all time. Williams took an almost scientific approach to hitting when he carved the strike zone into 77 cells, each the size of a baseball. His plan was to swing at balls in his “best” cells, which he knew would allow him to bat .400. If he swung at balls in his “worst” cells, his average would fall to .230. Essentially, Williams waited for the fat pitch.

Here is a graphic of Ted Williams and his strike zone:

While I would never compare myself to Warren Buffett or Ted Williams, I similarly look for an edge and only the best opportunities when I trade. Take, for example, a trade I recently recommended for subscribers of Cabot Options Trader.

ON Semiconductor (ONNN) is a relatively quiet stock that barely shows up on my radar when I’m looking for opportunities. In fact, the stock seems to make barely anyone’s radar as it trades around 800 option contracts a day. By comparison, another semiconductor stock, Micron (MU), trades around 80,000 option contracts a day.

However, starting last Wednesday, a trader (or traders) bought 5,500 ONNN January 10 Calls for prices ranging from $0.35 to $0.45. This was a large bullish order for this stock, and I began to do a bit of research on the company.

My research found two things to like about the company. One was that hedge fund titan David Einhorn’s Greenlight Capital had recently initiated a 15-million-share stake in the company. Second, the company just last week announced that its Board of Directors had approved a plan for the company to repurchase $1 billion worth of its stock.

As I was doing this research, the big trader bought another 1,500 January 9 Calls for $1.00.

Based on this bullish option trading, and the two positive news items, I felt that the odds of a successful bullish options trade had been tipped in my favor and I recommended that my subscribers buy the stock and sell the January 10 Calls. This bullish strategy is called a buy-write, and for every 100 shares of stock we buy, we can sell 1 call.

So what happened? We didn’t get filled on our order as the stock got away from us. On the close of trade, my order was cancelled and I told my readers that we would revisit the order the following day.

Then, the next morning, on the open, the trader or traders bought another 8,000 of these calls for prices ranging from $0.45-$0.55. This was an even more bullish trade as the trader bought more of the calls at an even higher price. The odds were tipping even more in favor of a successful bullish trade, so we once again sent an order for the buy-write and this time we were filled.

The stock was trading at $9.85 when we were filled on our trade. Here is the breakdown on the upside and downside to the position:

The most we can make on the trade is $60 per buy-write if the stock closes at 10 or above on January Expiration. This would be a yield of 6.38% in six weeks’ time.

If the stock is unchanged on January expiration, we will have created a yield of 4.25% in six weeks’ time.

Our breakeven on the trade is $9.40.

The most we could lose on the trade is $940 per buy-write if the stock were to go to zero.

On Friday, the day after we initiated the trade, the stock traded higher by 4% as the call buying frenzy continued.

Just like any trade, there is a chance this trade can fail. However, I think Ted Williams would agree that based on the recent hedge fund interest, the company’s newly announced buyback and the recent bullish option activity, that the pitch was right down the middle of the plate and that he would have swung at it.

Your guide to successful options trading,

Jacob Mintz
Chief Analyst, Cabot Options Trader/Cabot Options Trader Pro

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