Shares of America Express Company (NYSE: AXP) have rallied more than 132% since reaching a 52-week low of $10.33 on March 5 and have hovered around $25 for a couple of months. The stock has enjoyed bullish tailwinds ever since the company announced positive earnings after the market closed on April 23. Yesterday, we saw large call volume in the July options. But it’s important to remember that this volume is likely related to the fact that the stock trades ex-dividend today.
The AXP July 12.5 calls traded more than 238,000 times and the July 15 calls more than 205,000 times yesterday with the stock up 22 cents to $23.98 on the day. The July 12.5 calls were home to open interest of 11,500 contracts, and the July 15 calls were home to open interest of 9,500 contracts. You might be asking, “Was this a bullish investor buying calls that are way in-the-money instead of buying stock?” or “Was it a bearish investor selling calls rather than shares?”
The answer, in fact, is neither. This trade is neither bullish nor bearish. Instead, it was a trade designed to take advantage of the fact that shares of AXP will trade ex-dividend today. Because the shares will trade ex-dividend, the July 12.5 calls and July 15 calls are technically an exercise because holders of call options do not participate in the dividend. So rather than hold the calls, the owner of the calls should exercise them to get the shares, therefore collecting the dividend.
So why all of the volume in the calls? Well, the answer is because if the calls are an exercise, then that means if someone is short the calls and long the stock, they can make a profit on any call that is not exercised. What do I mean by that? Well, think of it this way. Any option market maker that is short the AXP July 15 calls is long stock against the calls as a hedge.
Say that the calls are worth parity right now, so that is $2.45 with the stock at $23.98. If the calls the option market maker is short are not exercised, then the stock will fall by the dividend amount. So the stock, in this case, falls by 18 cents, the amount of the dividend, dropping to $23.80. The call that the market maker is short also falls by the amount of the dividend to $2.27. Since the market maker is long the stock (a loser in the fall) and short the call (a winner in the decline) it seems that the market maker has no economic gain. But the market maker gets to pocket the dividend of 18 cents!
That is all there is to this trade: market makers trying to get short the calls so that they can be a part of the open interest in each of those strikes. So the volume that we see is market makers buying and selling the calls with one another. All of the trades go on the books as opening. The market makers are smart enough to exercise their calls, and all that is left is anyone who does not exercise.
Investors should be aware of activity like this so that they do not get fooled into thinking the options activity will give them some clues about the stock activity. When looking at options activity, particularly deep-in-the-money call (DITM) options, investors should be attune to this and other arbitrage activity to make sure they have a clear picture of the types of risks people are taking in their stocks.
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