Why Traders See Oceans of Upside in Transocean
The following post is a Guest Blog by CNBC Contributor Brian Stutland.
The latest chapter of the Deepwater Horizon saga has been written, and it could send shares of Transocean, the owner of the drilling rig that spawned the Gulf of Mexico spill, higher.
The U.S. Department of Justice reported on Thursday that Transocean agreed to plead guilty to violating the Clean Water Act. The company also agreed to pay $400 million in criminal penalties and $1 billion in civil penalties. (Read More: Transocean to Pay $1.4 Billion Over Gulf Oil Spill.)
Transocean's stock jumped over 6 percent on the news, primarily on relief that the penalty amount was not higher, and that DOJ will not pursue further prosecution of the company.
The stock also saw heavy bullish option trading. With the stock at $48.97, one trader bought 884 January 50-strike calls for $0.65 each. This trade will profit if RIG is above $50.65, or 3.24 percent higher, at January expiration in 14 days. (Read More: Option's Explained.)
Now that the market knows what Transocean's liabilities are in the Deepwater Horizon disaster, the stock could move higher.
The settlement amount of $1.4 billion will be paid over the next five years, and the funds will primarily be used for the benefit of the Gulf region hurt by the spill. The company had set aside $1.75 billion for the settlement, so clearly the final settlement less than could have been expected.
Since the oil spill, Transocean's stock is down about 50 percent, and has been trading at a discount to peers. Now that this suit is behind them, management can focus on growth, and the discount to peers should slowly disappear.
That said, it may be a volatile ride as the market sorts out what this means for RIG's financial position.
Therefore, the way to play the momentum in the stock is not buy buying shares, but by purchasing long calls, as this trader is doing. The trader is only risking $0.22, but the profit potential is unlimited.
When trading volatile, news-driven stocks, the most important thing is to keep reward-risk ratios high when structuring a trade, which means sticking with out-of-the-money options. However, just because you buy a call—especially with an out-of-the-money option—it doesn't mean you need to wait until expiration. You can buy a call option with the hopes of selling it at a higher price before expiration, a strategy I usually prefer to waiting to see if it finishes in the money.
Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."
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