Good morning. I was looking at the popularly traded coffee companies this morning: Starbucks (SBUX), Green Mountain (GMCR), and Dunkin Donuts (DNKN). Starbucks is the most actively traded, has a large institutional ownership, and would be a good candidate for time spreads and “income” trades. Volatility is low and just by looking at the open interest you get the feeling the most popular trades are selling covered calls. Starbucks is not a high volatility speculative product, and if you’re looking to trade Theta, this is a good product.
On the other hand, I was a bit surprised with the September open interest for DNKN, so lets try to decipher it.
45/50 calls and 45/40 puts – with roughly twice as many calls…
What’s going on here? Time to look at the charts. I added the trade levels on the chart so you can you see these block trade ‘expectations’.
and the 1 month, I’ve added another resistance line at 46.50. With the stock at 44, it’s no coincidence that the 45 calls are $1.50 and puts $0.50.
As you can see expecting DNKN between 40 and 50 looks like a safe range. Recent volatility has been low, and it’s been 5 months since we’ve touched 50. The trend is falling, slightly. That’s a counter-trend with the market and with their competitors. I find that odd. SBUX and GMCR are both reaching or at their highs.
Let go back to the open interest in DNKN and break it down.
- 1300 40 Puts
- 1600 45 Puts
- 2400 45 Calls
- 3700 50 calls
There’s a few possibilities here (for the sake of argument lets take 2) either these traders are sticking with the trend and selling calls to buy puts, which I partially suspect, or given the large blocks of puts and calls at 45 they might be creating straddles, which I doubt.
Lets take the basic bull spread: buy the 45 calls and sell the 50 calls.
From a percentage perspective that looks great. Max Loss $500, max gain $9100. The prices are saying that’s ‘unlikely’. But if it hits…
And the basic bear spread: sell the 40 puts and buy the 45 puts.
This also doesn’t look too bad from a percentage perspective. Max loss $1500, max gain $3500
Now what would it look like if we put the two together?
- Buy 20 45 Calls
- Sell 20 50 Calls
- Buy 10 45 Puts
- Sell 10 40 Puts
Interesting, remember this is a ratio spread, there’s twice as many calls moving as puts. And look at the December open interest… Is someone selling the option farther out as well? Very interesting! To keep it simple, we’ll just combine the two spreads which would give you a risk profile with a max loss of $2200 and a max gain on the put side of $2500, a max gain on the call side of $7600. The risk is time and that resistance level I spoke about earlier. DNKN has to close below $42.50 or above $46.50 to make this a good trade. This combination, is a better trade than a straddle, you are lowering your price and reducing the break even range. It’s a great set of options to play around with and an easy trade to ‘ease’ into. There’s still a good amount of risk, but if you expect DNKN to move 2 points in the next 30 days, this is the trade, and someone is backing you up!