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Morning Update

Yesterday Stanford C Bernstein downgraded shares of Vodafone to under-perform and adjusted their target share price downward. This sent the stock down 2.5% on the day and towards a major technical level for the stock. These enticed option traders to make bullish bets, expecting the stock will bounce off of support at 25. The biggest trade of the day was the purchase of 10,000 July 27 calls for $0.55 and the sale of 10,000 July 23 puts for $0.69. This trade is known as a risk reversal and was done for a $0.14 net credit. If VOD closes between 23 and 27 at July expiration, both options will expire worthless and the trader’s profit will be the $0.14 credit collected. If VOD rises above 27 the long call will come in to play and the trader will profit off of the stock’s upside. The risk in the trade is below 23, where the trader will be obligated to buy the stock at expiration.

The 25 level is an important area of support for VOD that was tested several times in 2011 and 2012. The stock touched it 5 times since 2010, closing below it for only a single day and never on a weekly basis. Each time the stock has traded at 25 it has bounced at least 4%, often more, over the subsequent week or two. This trade is a wager that this time will be no different. The risk in this trade is concentrated below 23, a level which Vodafone has not seen since July 2010. Although a bullish bet, the trade is designed to make money even if VOD goes nowhere and hangs around this level. Fundamentally Vodafone’s dividend yield of 6% at 25 should limit further downside in the stock to a modest amount.

Before jumping on this trader’s coat tails, remember that this trade obligates you to buy VOD at 23 should it be at that level or below come July. If you are not comfortable with that, then consider simply buying the July 27 calls to capture the potential bounce the stock could see without a fraction of the downside risk.

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