Specifically, several large blocks totaling roughly 5,000 contracts traded near the ask price yesterday on RIG's January 2011 25-strike put. Implied volatility on the option rose 2% by the close, indicating rising demand for this LEAPS strike. Open interest climbed overnight by 4,710 contracts, confirming that these were newly opened bearish bets.
By buying to open those January 25 puts, the trader could be anticipating a drastic decline for RIG during the second half of 2010. The puts were purchased for $2.17 each, so the speculator will begin seeing profits if RIG moves below $22.83 prior to January expiration.
But it's also quite likely these contracts were purchased as protective puts -- in other words, they're being used to hedge a long stock investment on RIG. By scooping up deep out-of-the-money, longer-term puts on a stock you hold in your portfolio, you've effectively bought an insurance policy on your shares.
In this strategy, the trader is likely hoping that RIG won't plunge, and those puts will expire worthless. However, should the worst-case scenario come to pass, the investor can rest a little easier knowing he's locked in a minimum exit price for his shares. Even if RIG should dive to, say, $15 per share by next January, the trader will still have the right to sell his stock for no less than $25 per share.
This tactic appears to be gaining traction among speculative investors, as uncertainty continues to surround the drilling industry. The International Securities Exchange (ISE) reports that traders have bought to open 1.16 puts for every call on RIG during the past two weeks. This ratio ranks higher than 83% of other such readings taken during the previous year, indicating that bearish bets are being purchased at a faster pace than usual over their bullish counterparts.
From a technical perspective, RIG is attempting to create a floor near the $45 level, which previously contained the stock's lows in December 2008 and January 2009. In fact, the shares are up 2.5% today, whittling away at their year-to-date deficit of 44%. However, the coast is hardly clear for this beaten-down equity. Thanks to RIG's steep slide, multiple layers of potential resistance are hovering overhead -- including the stock's 10-day and 20-day moving averages, as well as the round-number $50 level.
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.