A Big Investor Wants Out of This Stock, Now
Big investors are often thought of as the smart money in the markets. They are the ones with access to analysts at Wall Street firms who can offer valuable insights. They are also the investors with access to management teams.
This has been widely recognized since at least the late 1800s. At that time, Charles Dow, the investment analyst who created the Dow Jones Industrial Average, noticed that price action tends to follow three phases.
In the first phase, Dow believed the smart money was taking big positions. They acted before trends appeared. They would be buying when individual investors were selling and then, at tops, they would be selling when the general public was buying.
Since Dow’s days, the industry he popularized with his daily newspaper The Wall Street Journal, the financial media has become increasingly attuned to the news. That might make it difficult for large investors to complete their operations completely away from the public eye.
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Price Action Can Trigger a Trading Idea
On Thursday, Seagate Technology plc (Nasdaq: STX), appeared on the list of stocks with the largest losses. It seemed unusual because it was the only company from its industry on the list and companies in the tech sector tend to show correlations with other stocks in their industry.
The chart also offered no explanation of the price action. STX has been forming a base, acting similar to many stocks as it appeared to be preparing for an attempt to challenge its old highs.
However, the stock was selling off. We know that because the price action is the primary indicator for traders and the price was falling sharply.
Then, a news headline appeared on Bloomberg.
“Seagate Technology (STX) 4.2M Shares Are Said Offered at $56.35-$56.50/Sh via Morgan Stanley – Bloomberg”
This trade would be worth at least $235 million and indicates it is from a large investor. We don’t know why large investors sell, but the longer term chart could offer a clue.
The weekly chart shows that this is the highest level for the stock since 2014. The sale could be prompted by a concern that there isn’t much upside left.
The large seller could be motivated by potential resistance on the chart, a desire to sell at breakeven if they have held over the years, the desire to take a profit, knowledge about industry trends or hundreds of other factors.
A Trading Strategy to Benefit From Potential Weakness
The prospects of a short term rebound in STX seem to be remote. Traders should consider using an options strategy known as a bear put spread to benefit from the expected downward price move.
This strategy can be profitable when a trader is looking for a steady or declining stock price during the term of the options. The risks and potential rewards of this strategy are illustrated in the payoff diagram shown below.
Source: The Options Industry Council
A bear put spread consists of buying one put and selling another put at a lower exercise price to offset part of the initial cost of the trade. This trading strategy generally profits if the stock price moves lower. The potential profit is limited, but so is the risk should the stock unexpectedly rally.
The Trade Specifics for STX
The bearish outlook for STX, at least for the purposes of this trade, is a short term opinion. To benefit from this outlook, traders can buy put options.
A put option gives the trader the right, but not the obligation, to sell shares at a specified price until the option expire. While buying a put is possible, it can also be expensive. The risk of loss when buying an option is equal to 100% of the amount paid for the option.
To limit the risks, a second put can be sold. This will generate income that can offset the purchase price, potentially allowing a trader to buy a put with a higher exercise price. That increases the probability of success for the trade.
Specifically, the June 15 $52.50 put can be bought for about $0.40 and the June 15 $51.50 put can be sold for about $0.10. This trade will cost about $0.30 to enter, or $30 since each contract covers 100 shares, ignoring the cost of commissions which should be small when using a deep discount broker.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $30. This loss would be experienced if STX is above $52.50 when the options expire. In that case, both options would expire worthless.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in STX, the maximum gain is $0.70 ($52.50 – $51.50 = $1.00; $1.00 – $0.30 = $0.70). This represents $70 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $30 to open this trade.
That is a potential gain of about 130% of the amount risked in the trade. This trade delivers the maximum gain if STX closes below $51.50 on June 15 when the options expire.
Put spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $30 for this trade in STX.