Options Update: Mirant (MIR) Sees Spike in Call Volume

It would seem that my theme for today revolves the utilities sector. Earlier today in Schaeffer's Tool Box, I highlighted American Electric Power (AEP | Quote | Chart | News | PowerRating) as a potential bearish stock selection. Scanning our Intraday Volume Explosion List, fellow power-generation firm Mirant (MIR | Quote | Chart | News | PowerRating) grabbed my attention due to a heavy degree of call volume. With poor price action for a backdrop, this renewed attention to call options could have bearish implications for MIR. But before we dive into the pros and cons of investing in MIR shares, let's take a closer look at the impressive put volume on the equity that caught my eye today.

Call Selling or a Position Closeout?

Jumping into the activity, more than 20,600 calls have changed hands on MIR so far today. Most notable was a block of 20,000 contracts that traded at the stock's September 27.50 strike. The block crossed at the bid price of $2.95 at 10:10 a.m. Eastern time, hinting that these contracts were most likely sold. However, with open interest of 20,588 contracts at the September 27.50 call, it was hard to determine if these were sold to open or sold to close out an existing position.

To help clarify the situation, I went looking through our internal data for sizeable jumps in MIR call open interest to see if there was a recent transaction that could have accounted for a block of 20,000 call contracts being opened on the equity. Sure enough, open interest at this front-month strike jumped by more than 20,000 contracts on August 12. Scouring through options data on Thomson One, I finally found the original trade: a block of 20,000 September 27.50 calls, trading at an ask price of $1.60 on August 12 at 2:58 p.m.

Given this data, and the fact that volume on MIR's September 27.50 call has yet to exceed open interest, I felt safe in assuming that today's volume was the closure of a long position on the security. The trade breaks down like this: on August 12, the hypothetical trader purchased 20,000 September 27.50 MIR calls for $1.60, or a total outlay $3,200,000 -- ($1.60 * 100)*20,000 = $3,200,000. Fast forward to today, and the trader closes out the position by selling his 20,000 September 27.50 calls for $2.95, receiving a pay day of $5,900,000 -- ($2.95 * 100)*20,000 = $5,900,000.

For those keeping tabs at home, that's a gain of more than 84% in roughly 11 days! Furthermore, this trade is an excellent example of the leverage achieved by trading with options. If the trader had simply purchased the stock, he would have only realized a gain of only 10% on his MIR position. While this is still a stellar return in just 11 days of trading, it pales in comparison to the 84% gain achieved by trading options on the shares.

But there is still one question that is bugging me when it comes to the closer of this MIR call position. Did the trader cut his gains short, or was this a wise exit point for this trade? Clearly, if his target gain on the position was something near 100%, then it fit with his methodology. But could he have profited more by letting the trade ride? Let's see if the stock's technical picture or sentiment backdrop provide any clues on the potential for additional profit from this position...

Technically Speaking

On the technical front, the short-term outlook for MIR looks uncertain. As noted on the prior page, the shares have rallied more than 10% since setting a near-term bottom on August 12 (this hypothetical trader had some very good timing). The stock has reclaimed its 10-day and 20-day moving averages, and even bested potential round-number resistance at the 30 level. However, the shares are approaching former support at the 30.50 level. This region buoyed MIR for the latter half of July, and could provide staunch resistance to an extension of the stock's budding rally. Furthermore, a reversal at 30.50 could be disastrous for the shares, returning MIR to the clutches of the bears which have forced the stock more than 23% lower since the beginning of the year.

The Sentiment Drivers

Meanwhile, sentiment among options traders was beginning to get a bit frothy for MIR. The stock's Schaeffer's put/call open interest ratio (SOIR) of 0.29 indicates that calls more than triple puts among near-term options. Furthermore, this ratio ranks below 83% of all those taken during the past year, indicating that options traders have been more optimistic toward MIR only 17% of the time in the prior 52 weeks.

If today's volume was indeed the closure of 20,000 calls on MIR, we should see this ratio rise a bit tomorrow. However, the open interest picture for the security remains heavily bullish even with these contracts out of the picture. Peak call open interest resides at the 32.50 strike, with more than 26,000 contacts, while another 20,000 reside at the deep out-of-the-money September 40 strike. This attention to overhead call open interest means that investors are looking for a winning streak from MIR, a configuration that has negative implications from a contrarian perspective.

On the other hand, pessimism is thick among short sellers and Wall Street analysts. More than 11% of MIR's float is sold short, and Zacks.com reports that all 6 analysts following the shares rate them a "hold" or worse. However, I would argue that this negativity is par for the course given the stock's poor technical performance. As such, short sellers would be less likely to buy back their winning positions if there is the potential for MIR to extend its losses.

The Verdict?

Personally, I believe that the hypothetical trader has the right of it. Technical resistance looms just overhead in the 30.50 region for MIR, and the stock will likely receive no help from short sellers or analysts given its abysmal technical performance. What's more, I cannot emphasize the need for predetermined target profits and stop-loss targets prior to entering a trade. If this trader set a target for a gain of 100% on his MIR call, then hitting 84% could be a nice settlement given the stock's technical outlook. Holding on any longer could have scuttled the whole deal.

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