One options trader is taking a serious risk on Sirius XM. But so long as no horrible news is around the corner, it's a risk that will likely pay off.
Shares of Sirius XM started the week strong after Bank of America media analyst Jessica Cohen reiterated her "buy" recommendation on the stock. One of the reasons Cohen cites for recommending Sirius includes the competitive uniqueness of the company.
Sirius XM has a different structure than competitors like Pandora and Spotify, because Sirius XM focuses on automobiles rather than mobile and computer software. This leaves Sirius XM untouched in the field, as new entrants like Apple battle it out for the software sector.
In addition, Cohen notes that Sirius XM is growing rapidly and boosting its financials at a time when the auto market looks to be improving.
This is an example of an expert and her remarks affecting the market. Indeed, on the whole, the mean target price for the stock is $3.66. This is 12 percent higher than where the shares opened Tuesday, and reflects a very bullish opinion on the Street.
One thing to be wary of, however, is the exposure that the stock has recently gained. When a very famous person comes out and recommends a stock and everyone in the market buys it up, it often leads to an overvaluation of the price that the market eventually corrects.
The best way to pick outperforming securities is to find the underpriced ones that no one else has noticed. That way, when others realize the value to gain from it, you will capture all of the growth. On the contrary, by following big calls, you allow for the potential to accidentally buy the stock above fair value and lose money when the market corrects itself.
However, one trader believes that Sirius XM is still undervalued. In a large bullish bet, this trader sold almost 50,000 2-strike puts shortly after Tuesday's opening. This trade allows the investor to collect the 15 cents per option as a premium, but carries with it the obligation to buy the online radio provider's stock if it dips below $2.00. This trade will lose money if Sirius drops below $1.85 by the trade's expiration on Jan. 15.
This allows the trader to collect $750,000 from the premiums on an option that will likely expire worthless. But there's one problem. The trader is then capping out the maximum gain at $750,000, while facing a maximum loss of $16.2 million if the stock drops to 1 cent, in which case the trader has to buy the shares for $2.00 a piece.
Yet while the profit-loss comparison seems greatly lopsided, the trader is incredibly unlikely to see the day when Sirius XM drops to zero.