Options activity spikes after Pfizer (NYSE: PFE) earnings surprise

Pfizer (NYSE:PFE) reported earnings on Wednesday morning, and the investing community was not too impressed. The drug maker missed per-share earnings estimates by a penny and guided its fiscal year 2010 outlook below the consensus (although the firm did issue an upside guidance for 2012). The stock turned lower on the news, dropping 3.2% to end the day at $18.62.

Implied volatility came in as a result of earnings being out of the way. The 19-strike straddle, which closed at 88 cents on Tuesday, was priced at 81 cents at Wednesday’s close. This indicates a projected additional move of about 4.3% between now and February earnings expiration in slightly more than two weeks.

There were two trades in Pfizer’s options pits that caught our interest yesterday. First, it appears as though investors were rolling front-month, near-the-money calls out to the March series in order to gain a few more weeks of bullish exposure. Shortly after the opening bell yesterday, a block of 10,000 contracts changed hands on the February 19 call, trading for 29 cents. At the same time, another block of 10,000 traded at the March 19 call, at the price of 55 cents. It appears as though this investor was selling the front-month call and buying the March call, paying a net debit of 26 cents to do so. This was only one of many trades to occur in these strikes.  In fact, by the end of the day, the February 19 calls had changed hands more than 55,000 times and the March 19 call posted volume of about 29,000.

In other news, we saw a spread that consisted of put selling and call buying in the September series. At 11:05 AM Eastern Time, a block of 8,244 out-of-the-money September 15 puts traded for 49 cents while the same-sized block of September 20 calls (also out-of-the-money) was trading for 83 cents. The put contract traded between the bid and the ask prices while the call changed hands closer to the ask price.

This strategy, a risk reversal, also known as synthetic long stock, is effectively a lower-cost way to take a bullish position in the underlying stock without paying $18.62 per share. This particular strategy was opened for a debit of 34 cents per contract. Maximum profit is theoretically unlimited (if PFE is trading above 15 when September options expire, the short put expires worthless and the long call, once in-the-money, moves step-for-step with the stock).

Maximum loss, however, is also unlimited to the zero mark if PFE moves below 15. In this scenario, the long call expires worthless and the loss for the short put is calculated as the strike price minus the stock price plus the original premium paid. Breakeven for this strategy is $20.34, or the long call strike plus the net debit paid. This is about 9% above Pfizer’s current level, but remember that these particular options do not expire until September.

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