Palm (PALM) Unusual Option Activity

At 12:40pm, an institutional trader put on a very large crazy trade on PALM.  Take a look:


- Sold to open 9,500 contracts of April $7 puts for $0.43 credit
- Bought to open 19,000 contracts of April $9 calls for $0.68 debit
- Sold to open 38,000 contracts of April $11 calls for $0.21 credit


Previously established open interest on each of those strikes was less than 1200, so these are all opening positions.  Now, take a look at the attached P&L chart above.  Basically, the trader expects the stock to rally back to $11 by April expiration, but not above $13.  On the downside, the trader is fully protected with no loss or gain as long as the stock stays above $7.  This is roughly $2.5 million bet.  


If you want to piggy back on this unusual activity, I would suggest the following unbalanced skip-strike butterfly spread:


- Buy to open 2x April $6 calls
- Sell to open 3x April $8 calls
- Buy to open 1x April $9 calls


The whole butterfly spread is going for a net debit of $2.20 as of Wednesday market close.  The trade remains profitable as long as the stock stays above $7 by April expiration.  The trade will produce a profit of nearly 80% if the stock is at $8 on April expiration.  If the stock goes above $9, the trade will generate 35% profit.  I like these odds much better than the monster trade above.  I will place the order when the market opens on Thursday.  

Keep in mind that there has been very negative coverage of PALM lately by analysts.  On 2/23/10, BofA and Macquarie both downgraded the stock to Neutral and Underperform, respectively.  On 2/12/10, there was a rumor that PALM was halting production in some facilities, but Kaufman Bros. later suggested that it was a mere slowdown not a full halt due to Chinese New Year (I wonder why didn't Apple or RIMM or others made similar announcement).  Lastly, just today Canaccord went cautious on PALM on rumors that Verizon might be considering dropping PALM altogether due to lackluster sales.  


Whether these issues are real or not, PALM shares have precipitously dropped from $14 to $8 in one month and short interest has soared to ridiculous 45%.  Earnings are expected on March 18 after the close, so this could be setting up for a monster rally.  Or at least this one trader with a monster bullish bet seems to think that way.  


I like the odds of my butterfly spread because it also meets the 5-10-20 rule.  More on this rule, go to: http://fahadstockworld.blogspot.com/2010/02/5-10-20-rule-easy-way-to-passive.html


Good luck!