A friend of mine recently traded World Wrestling Entertainment (ticker WWE) for a nice gain. The sad truth is that both of us are in our 30’s, and we are pro wrestling fans. The first step toward recovery is admitting you have a problem…
Redneck hobbies aside, WWE has had a nice year, punctuated by the recent launch of its own network. The chart reflects the market’s optimism about the future of the company:
That is a beautiful chart. The stock has nearly tripled in about six months time! However, I have missed out on the entire rally because the valuation of the company worries me. With a P/E ratio of 743 (!), the stock looks priced for perfection. I’m sure shareholders would point to the launch of the network and the incredible earnings growth potential. But even when growth projections are taken into account, the WWE’s PEG ratio is still a whopping 37.19!
I typically avoid shorting stocks, as even overpriced growth stocks can continue to rise unreasonably for years. Remember, a stock is worth exactly what someone is wiling to pay for it, and as long as there are buyers, a stock with upward momentum can continue to rise. However, I must admit that I spent some time this afternoon checking out the prices of WWE puts. When looking at the October, 2014 option chain, I noticed something strange that stood out to me. Take a look:
The open interest in the October options is generally almost nonexistent, but there are relatively massive open interests in $17.5 puts and $35 calls. At the current prices, these options are worth about $4 million combined! It’s surprising to see such high open interest in only two options like this, especially when they are not even the strike prices closest to the current share price of around $30. This fact makes me wonder if these two positions are held my the same person. Maybe one position is a hedge against the other. If these positions are held by the same person (or more likely the same institution), this entity has a $4 million bet that seven months from now WWE will be trading nowhere near where it is now!
I admit I might take a little nibble at a WWE put at some point in the near future, but I’m not brave enough to predict a 40%+ fall in the share price! That leads me to guess that the $35 call position could be a (possibly desperate?) attempt at hedging the $17.50 put position that, so far, has turned out to be a brutally bad decision.
Of course my whole hypothesis could be completely wrong, but since none of us are likely to ever know one way or the other, I’m going to go ahead and say is is certainly correct and, I might add, quite ingenious!
Again, I have no position in the stock or its options at this time. Sadly, for the time being, my only interest is in the product.
Up to this point, I have tried to keep the content on this site pretty simple. If you were completely lost during today’s post, don’t worry. Options can seem pretty complicated if you don’t know what you are doing. But fear not: my book, Beating Wall Street with Common Sense: How I Achieved a 400% Return from my Dorm Room, (which includes a full chapter on how I’ve made a bunch of money trading options) is now available on Amazon!