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A Long Straddle on IBM (IBM)

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Employing the Zacks Most Active Options filter for today’s edition of Trading Tools, a different security caught my eye: blue-chip bigwig International Business Machines (IBM - Free Report) .

Before we begin, let's explain the contrarian stance that makes Schaeffer's so unique. When searching for a bullish pick, we like to see heavy skepticism toward an outperforming stock, as this leaves ample room for upgrades or other positive catalysts to fuel the stock higher. When searching for a bearish pick, on the other hand, contrarians are looking for significant bullish sentiment toward an underperforming stock, as we believe an excess of optimism is a sign that everyone has already bought into the stock and sideline money is virtually tapped out.

However, keep in mind that some optimism and pessimism is genuinely warranted and isn't always a contrarian indicator – like an outperforming stock with many "buy" ratings or an underperforming stock with a plethora of "sell" ratings.

A Balanced Bet on Big Blue

Shares of IBM tagged a fresh 52-week peak of $129.47 on Thursday, sparking a wave of optimistic option activity. During the course of the session, the stock saw about 33,900 calls cross the tape, more than doubling its average daily volume of fewer than 10,800 contracts. Most popular was the out-of-the-money Jan 2010 135 call, which saw close to 10,700 contracts change hands.

Today, the equity's near-the-money December 130 call has garnered the most attention, with almost 3,000 contracts exchanged so far. However, it was today's option activity surrounding the January 2010 125 strike that really piqued my curiosity.

At 12:10 p.m. Eastern time, one investor purchased 100 January 125 calls for the ask price of $5.75, and simultaneously bought 100 January 125 puts for the ask price of $1.39. In other words, at least one long strangle strategist is betting on a significant price swing for IBM in the short-to-intermediate term, but doesn’t want to pick a direction.

Since all of the options were purchased, the strangle was established for a net debit of $7.14 ($5.75 + $1.39), representing the investor's maximum potential risk on the play. However, in order to avoid forfeiting the initial premium paid, the strategist needs the shares of IBM to violate one of two breakeven rails by January options expiration: the $117.86 level (strike – net debit) or the $132.14 level (strike + net debit).

Should Big Blue perforate the lower breakeven level by options expiration, the straddle trader could make a pretty penny, though profit is limited to $117.86 (strike – net debit), assuming the stock falls to zero. On the other hand, profit is theoretically unlimited should IBM breach the upper breakeven level, as there's theoretically no limit to how high the security could skyrocket.

Facing an Old Foe on the Charts

Technically speaking, shares of IBM have extended their string of new highs today, touching the $129.58 level in early trading. Since the start of the year, the stock has advanced more than 53% along double-barreled support at its 10-week and 20-week moving averages. However, from a longer-term perspective, the equity is now facing a staunch technical ceiling in the round-number $130 level, which rejected the security's rally attempts in mid-2008.

What's more, there are more than 37,000 open call positions at the December and January 2010 30 strikes. This heavy accumulation of bullish bets could exert some options-related resistance in the short-to-intermediate term.

Word on the Street

On the sentiment front, it appears IBM's bullish bandwagon may be reaching full capacity – meaning the stock could face a lack of potential sideline cash to help fuel it through resistance. During the past couple of weeks, speculators on the International Securities Exchange (ISE) have bought to open more IBM calls than puts, as indicated by the equity's 10-day call/put volume ratio of 1.44. This reading registers in the 80th annual percentile, implying that traders on the ISE have initiated bullish positions at a faster pace only one-fifth of the time during the past year.

Plus, the brokerage bunch is already optimistically aligned. According to Zacks, IBM has garnered 10 "strong buy" ratings and three "buy" ratings, compared to just eight lukewarm "holds" and not a single "sell" rating.

In Conclusion

While IBM's technical feats of late definitely deserve some recognition, the abundance of bullish sentiment could actually hamper the stock's attempt to win the battle with the $130 level. With most of the Street already in IBM's corner, the stock could have a toilsome time attracting fresh buying power.

However, as far as the aforementioned long straddle strategist is concerned, another rejection for IBM at the $130 level doesn't signal defeat – as long as the stock's pullback is significant enough to cross the lower breakeven threshold.

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