Bull Bets on a Short-Term Bounce for Massey Energy

Specifically, the speculator bought to open 500 contracts of the stock's May 45 call, and simultaneously sold to open 500 contracts of MEE's May 49 call. MEE was trading at $42.23 at the time this spread was initiated, placing both calls out of the money.

By purchasing the lower-strike calls, the trader is revealing that he expects MEE to rally above $45 during the short term (May-dated options expire in a little less than five weeks). By selling the higher-strike calls at the same time, the options player has effectively lowered both his cost of entry and his break-even point on the trade. The spread was opened for a net debit of $1 per pair of contracts, so the trader will begin seeing profits on any move beyond $46 by MEE shares (the purchased strike + net debit).

Of course, the trade-off is that the speculator has also limited his profit potential. Thanks to those sold May 49 calls, the maximum gain on this bull call spread is limited to $3 -- or the difference between the two strike prices, less the initial net debit. On the other hand, if the trader had simply purchased the May 45 calls on their own, his maximum potential profit would be theoretically unlimited.

The best-case scenario for this long call spread is for MEE to settle squarely at $49 upon May expiration. The sold calls could be left to expire worthless, requiring no further action on the trader's part to close out this leg of the spread. Meanwhile, the trader could then sell to close his in-the-money May 45 calls to lock in the maximum possible gain of $3 on the spread.

This cautiously bullish speculator could be expecting an upbeat earnings report from MEE, which is slated to unveil its first-quarter results after the close on Wednesday. Ahead of the event, analysts surveyed by Thomson Reuters are expecting the company to report a quarterly profit of 28 cents per share.

However, as noted earlier, MEE must tackle several layers of looming resistance before this long call spread will attain profitability. Most pressing is the stock's 10-day moving average, which capped MEE's progress in Tuesday's session. The shares haven't managed a single daily close above this descending trendline since news of the mining tragedy first hit Wall Street.

Elizabeth Harrow is a senior equities analyst and financial writer in the research department at Schaeffer's Investment Research. She is featured in the video series Schaeffer's Daily Q&A on SchaeffersResearch.com.