The big news Thursday morning, as I write this pre-market, is the Xi-Trump Summit in Beijing. 

The President of China and the U.S. held nearly three hours of talks that included discussions about the Middle East, Ukraine and Taiwan, as well as economic issues affecting both countries. 

With the mood positive, the pre-market S&P 500 futures are up. We’ll see if they stay up. Given the index is up nearly 9% in the past month, I’d say the chances are good. 

In yesterday’s unusual options activity, Shopify (SHOP) calls had the highest and 20th-highest Vol/OI (volume-to-open-interest) ratios at 120.63 and 30.05, respectively. At first glance, the two call lines up nicely for a Bull or Bear Call Spread. However, a closer look at Shopify’s trading from Wednesday suggests a more interesting trade is in play. 

And while I’m confident it’s not something I’d be comfortable attempting, the institution that carried out this more complex options strategy obviously felt differently. 

Read on, and I’ll reveal the options strategy used here.

The Options in Question

As I said, the two calls above had the highest and 20th-highest Vol/OI ratios yesterday. Together, they form the two legs of a possible bull call spread or bear call spread. 

For those unfamiliar, the former is bullish, while the latter is bearish. Both are defined-risk options strategies. The former would involve buying a Sept. 18 $140 call and selling a Sept. 18 $175 call. The latter is the reverse: you buy a $175 call and sell a $140 call.

However, in addition to these two unusually active calls, there were two more high-volume trades with high open interest, which put their Vol/OI ratios below the screening criteria for inclusion.  

These two calls also had Sept. 18 expirations, but with strike prices of $195 and $160. They could also combine for a bull or bear call spread. 

Before I get to the options strategy in play, let’s consider both potential bull and bear call spreads. 

The Bull and Bear Call Spreads

Using the prices from the options flow data above, you bought the $140 long call for $3.02 and sold the $175 short call for $0.80 in premium. That’s a net debit of $2.22. In the second combination, you bought the $160 call for $1.43 and sold the $195 call for $0.43. That’s a net debit of $1.00. 

You’ll notice that both combinations had strike differentials of $35. The importance of this will reveal itself shortly.

As for the bear call spreads, the first combination involves buying the $175 long call for $0.80 and selling the $140 short call for 3.02 for a net credit of $2.22. The second combination buys a $195 long call for $0.43 and sells a $160 short call for $1.43 and a net credit of $1.00.

For the two bull calls, the $140/$175 combination has a 13.6% chance of making money, but the maximum return is approximately 1,477%. So, the risk/reward is on your side. As for the $160/$195 combination, there’s a 7% chance of making money with a maximum return of 3,400%. 

For the two bear calls, the inverse of the bull spreads exists. So, while your chances of making money are likely near or above 90%, the risk/reward is highly skewed to risk rather than reward. It’s a no-go.

The Options Strategy in Play

At first, I thought the four different calls might represent a Broken-Wing Butterfly (BWB) Call options strategy. The BWB is a directional strategy that is neutral-to-bearish and designed to generate income. It combines a bull call spread and a bear call spread, which I discussed earlier. 

The only problem is that the BWB uses three call strikes rather than four. So, for example, you might buy one $140 long call, sell two $160 short calls, and buy one $175 call. That produces a net debit of $0.96 [$3.02 for $140 - 2*$1.43 for $160 call + $0.80 for $175 call]. With the BWB, you want a net credit. The other possible combinations also produce net debits, so this strategy is out. 

It brings me to the Long Call Condor. 

This strategy is mildly bullish and assumes volatility will decline, while the share price will move up into a specific range by expiration. 

In the case of yesterday’s four calls, the trade would go as follows:

1) The institution bought 45,999 $140 long calls to open for $13.89 million ($3.02 a contract).

2) Sold 45,999 $160 short calls for $6.58 million ($1.43 per contract) in premium. 

3) Sold 45,999 $175 short calls for $3.68 million ($0.80 per contract) in premium, and

4) Buy 45,999 $195 long calls for $1.98 million ($0.43 per contract). 

That’s a net debit of $5.61 million [$13.89 million + $1.98 million - $6.58 million - $3.68 million].

There’s only one problem: That leaves out 91,998 contracts unaccounted for. So, it’s not a straight long condor. The best possibility is that the institution did a long condor and a bull call spread. 

The long condor would take out 45,999 call contracts across all four strike prices. That leaves 45,999 $160 calls and 45,999 $195 calls. You would sell the 45,999 short $160 calls for $6.44 million in premium [45,999 * $1.43 * 100] and buy 45,999 long $195 calls for $1.98 million for a net credit of $4.61 million.   

So, in addition to the $970,000 in net credit from the long condor, the remaining 45,999 $160 short calls would be sold for $6.58 million in premium, bringing the net credit to $7.55 million. 

The two trades would have an overall net debit of $1 million [$5.61 million net debit from the long condor - $4.61 million from the bull call spread].

The institution that placed this hopes that SHOP stock hits $160 at expiration. Beyond $160, the bull call spread starts to eat into the long condor profits up to $175.

This is why traders get paid big money. It’s a very interesting options strategy.   

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