US Steel Options Head Fake

Posted on October 25th, 2011

I always like to take note when volume outpaces the open interest of any particular option. It signals that someone or a few people have decided to separate from the heard and take position of strong conviction.

Yesterday this happened in advance of US Steel’s Q3 earnings release. The November 30 Calls for symbol X (US Steel) traded over 10,000 contracts against an open interest of 2,700, and just about all of it was buying new positions. With less than 4 weeks until expiration, the stock would have to appreciate over 20% from its Thursday closing price of 24.5 to get above 30. By the end of the day, those call options were going for ~0.35. Usually this indicates a speculative play and in this case it cost $350,000 to establish. Not what I would call someone’s off-the-cuff bet.
Fast forward to Tuesday morning and X beats the street’s estimate of $0.55 by reporting $0.72 a share. A nice surprise for sure. However, they guided lower for Q4 and the stock steadily sold off all day into the mid 22’s. The calls dropped in half from $0.35 to $0.17. Not really the bullish story yesterday’s activity indicated.

What can we learn from this? While reading the tea leaves through the options market remember this:

1-OTM options that have high volume compared to their open interest indicate speculative plays.
2-You can’t always read the story from one data point with options. This might have been the protection of short position going into earnings.

Bottom line, watching the options market for hints on earnings doesn’t always accurately predict the outcome. This trade still has 3 ½ weeks to work out, but in the wake of Tuesday’s performance the probability of success is dropping fast.

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