Wells Fargo’s (WFC) alleged fraud is the talk of the investing and trading world, but the news plays no part in my trading at Cabot Options Trader and Cabot Options Trader Pro.
Instead, I turn to my options trading scanner to see how sophisticated hedge fund and institutional traders are trading WFC stock. This information gives me the best ideas for potential trades.
One of the most popular ways these sophisticated traders gain exposure to a stock is with call and put options.
Here’s what that means.
If a trader is bullish on a stock, he might buy a call. A call option gives its holder the right to buy 100 shares of the underlying security at the strike price at any time prior to the options expiration date. The most the buyer of the call can lose is limited to the premium he paid. However, the upside profit potential is unlimited!
Alternatively, if a trader is bearish on a stock, he might buy a put. A put option gives its holder the right to sell 100 shares of the underlying security at the strike price at any time prior to the options expiration date. The most the buyer of the put can lose is the premium he paid.
So what does my options scanner find the largest traders doing in WFC options? Are they buying calls expecting the stock to bounce back or buying puts expecting further downside?
Traders are buying call options, betting that WFC stock will recover in the coming weeks.
Here’s an example: Last Thursday, a trader bought 15,000 WFC October 46 Calls for $1.40. This trader would need WFC to trade above 47.40 (higher by $1.70) on October 21 for the trade to be profitable. If the stock were to fall, the most the trader could lose on this trade is the $2.1 million he paid for the position. However, if WFC rallies, the trader has the right to buy 1.5 million shares of WFC stock at 46 at any point before October 21.
Here is the profit and loss graph for one WFC October 46 Call:
As the chart shows, if I buy one WFC October 46 Call, the most I can lose is $140 if the stock trades sideways or goes lower. However, if WFC bounces back, my profit potential is unlimited to the upside.
So my scanning tool is showing me that the hedge funds are bullish on WFC stock, and I likely will patiently wait for a good entry point to execute a bullish call position, targeting a call with a bit more time for the stock to turn around.