On Friday, March 1, the sequester is scheduled to take effect, and it will remove about $45 billion from Pentagon programs. Despite this, Lockheed Martin saw heavy call option trading on Friday, with five calls trading for every put.
The biggest trade of the day was the purchase of 5,000 April 92.5-strike calls for $0.65. This was done with the stock at $88.50, and it is a bullish bet that the stock, which is down 4.5 percent year-to-date, will rally by at least 5 percent over the next month and a half.
Right now, there are two risks facing this stock: the sequester, and the Pentagon's grounding of the F-35 Joint Strike Fighter.
Despite the looming deadline for the sequester, the defense and aerospace sectors are holding strong near 52-week highs. Meanwhile, while Lockheed is off of its lows, it is also well off its 52-week high—demonstrating weakness relative to its peers. Lockheed has said that they expect sales to be flat as a result of government budget cuts. To make up for this, the company is looking to cut costs and increase sales abroad.
The other issue facing Lockheed Martin is the grounding of the F-35 Joint Strike Fighter. The fighter is currently seven years behind schedule, and well over budget. The aircraft is still in its testing phase, and groundings like this are not uncommon. The reason for the grounding was a cracked turbine blade, and Lockheed says they expect to have a solution by the end of the week.
If there is a quick fix, then the program will be back up and running in no time. That said, the problem has made potential foreign purchasers more and more skeptical. For instance, Australia is expected to order 100 F-35s, a $13.21 billion deal. However, Peter Goon, a consultant at the Air Power Australia think tank, told Australia's parliament, "The Joint Strike Fighter is a failed program with no prospect of recovery."
Clearly, if Lockheed continues to see problems and delays in the F-35 program, they become more likely to lose the international customers that they will need in order to grow down the road.
I think the stock's downside is somewhat limited by its 5 percent dividend yield, and the sequester could be factored into the stock's price already. I would not own the stock here because of the headline risk right now.
But buying calls could be a low-risk, potentially high-reward trade if there is good news about the F-35 and the sequester this week. Lockheed is making lower lows on a weekly chart, but positive upward momentum could potentially take the stock to new highs on a short squeeze.
To play a short squeeze, I like the use of calls rather than stock—but I'd keep a tight stop at $87 to dump those calls, because time will begin to work against you once the stock breaks below that support line.
Disclosures: None to report.
Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."