In the options market, big money can be made pretty quickly. For one trader, it only took a day. Let me explain how he did it.
Refining stocks plummeted on Tuesday, after Valero said it expects to pay $300 million to $400 million to comply with cleaner gasoline requirements expected to be in effect by 2017.
This sent a wave of selling through the refining sector, as traders, worrying about margins, heavy maintenance ahead of the summer driving season and the expenses related to the new emissions regulations, took the opportunity to take profits in these names.
In addition, significant weakness in gasoline futures prices has not helped. Options volume in Phillips 66 has been heavy the last two days, and the focus was on defensive trades.
One of Tuesday's biggest trades was the purchase of 1000 April 65-strike puts for $0.65, with the stock at $67.85. And then this morning, with PSX trading lower, those puts were sold back for $2.35. This trade risked $65,000 in options premium, and turned a profit of $170,000 in one day.
Pretty impressive, but what does this trade tell long-term investors who are long the stock?
It says that option traders have already switched from buying puts to selling them. This shows they think that this move, which looks quite panicked, is overdone and due to reverse or at least fizzle out. The selling in these names is due to the fact that, because these stocks have had such a great run over the past few months, most traders have large gains on their books. Now that the stocks have ticked down, those traders are selling to protect their profits while they wait for more certainty on the situation going forward.
If you are a longer term investor, consider instead selling calls against the stock to cushion the downside and take advantage of the spike in implied volatility.
Similarly, for traders who don't have a stock position but want to buy the dip, consider selling puts at a level at which you would be happy to own the stock. This strategy lets you take advantage of the spike in implied volatility, and can produce income and possible a great long-term entry point into the stock.
I have no position in PSX, but I do hold stock in Marathon Petroleum, another refiner—and I have, over the last few days, begun selling calls against my stock to take advantage of high premiums.
—Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."
Disclosures: No position in Phillips 66; owns another refiner, Marathon Petroleum.