LinkedIn stock rolled out to great fanfare and considerable volatility two weeks ago, and its options debuted last Friday (one week ago as of this writing). But the shares have declined considerably since the $122.70 peak of its maiden session on May 19.
LNKD shares finished Tuesday down 7.6 percent to $81.58. Until then, the $85 level had proven to be solid support for the shares since the first day of trade despite some valuations that were much lower. (See tickerfor today's stock quotes.)
Needless to say, even the most bullish of prospective buyers have become wary of the name. But rather than an outright purchase of shares, this provides a classic example of a situation where options can provide a better risk/reward proposition.
With LinkedIn finishing Tuesday at $81.58, a "synthetic" position could have been opened by buying calls and selling puts for a net cost of $79.50. That $2.08 difference could even be applied to buying a lower-strike put as a hedge.
In essence, this would be the same as buying LNKD stock and getting the put for free as insurance.
Interestingly, this bullish trade is made possible by a strong demand for downside positions. The price differential in LNKD options was created by the demand for buying puts or for borrowing shares to sell them short.
As OptionMonster reported last week, it has been extremely difficult to take a bearish position on the stock because the price of puts is so high and the shares are so hard or expensive to borrow for a short sale. As a result, there is a huge difference in the value of the calls and puts.
A trader could even have sold the July 80 puts for $8.60, getting a profit at expiration anywhere above $71.40 and outperforming the stock to the upside up to $88.60.
When put/call parity is not in place — which is a rare occurrence — a trader can buy the synthetic and short the stock for a guaranteed profit. This reflects the fact that shares are very expensive to short, if they can be found at all.
On Friday the implied volatility of the puts was 100 percent for the puts and half that for the calls. That disparity has diminished but, as of Tuesday, the implied volatility was still 85 percent for the puts and 60 percent for the calls.
Let me be absolutely clear: I am NOT bullish on this stock. But those who are should be using the options, not buying the shares.
McKhann has no positions in LNKD.
Options Trading School:
CNBC's Companies in the News:
Chris McKhann is an analyst and writer for OptionMonster.