Yahoo! (NASDAQ: YHOO) traders simulate a short stock position with options

Late last week, Yahoo! (NASDAQ: YHOO) and Microsoft (NASDAQ: MSFT) learned that their proposed joint venture in the world of search was approved by U.S. and European regulators. Even with this positive news on the tape, an investor opened a synthetic short stock position on YHOO shares in Friday’s session, using options to simulate a short-stock position.

To build this type of strategy, the investor buys puts and sells an equal number of calls with the same strike and same expiration month. The net result simulates the profit/loss profile of a short stock position. On Friday, the January 2011 17.50 call and put saw the attention, as 7,500 contracts traded on both strikes at 11:15 AM Eastern Time. The calls were trading for $1.14, going off near the bid price, while the puts changed hands at $3.10, trading above the ask. It appears as though the calls were sold and the puts were purchased, resulting in a net debit of $1.96 per spread.

Because the trade simulates a short stock position, it carries unlimited risk if the stock rallies. The profit potential, however, is also significant, and is unlimited until Yahoo! hits zero. The profit/loss chart below was built in less than a minute with a free virtual trading account from OptionsHouse. Construct charts of your own (and gain access to other tools, such as volatility charts and a probability calculator) by signing up today.

In addition to this synthetic short stock position, we also saw some upside call selling in Yahoo, as more than 3,000 January 17.50 calls were sold for $1.11 per contract in early-afternoon trading. If these were in fact sold to open, the investor keeps the premium collected as long as YHOO shares are trading below $17.50 when the options expire. Of course, the call seller can close this position at any time by buying the options back to close.

In shorter-term developments, volatility for Yahoo’s March series is drying up with the search-deal decision out of the way and earnings not expected until on or around April 21st. The at-the-money (16-strike) March straddle closed at 94 cents at Friday’s close, down from $1.02 at Thursday’s closing bell. The options market currently predicts a 94-cent advance or decline in YHOO between now and March 19th. That’s a move of about 6%.

More on YHOO:

Longer-dated options action in Yahoo! (NASDAQ: YHOO), Vanda (NASDAQ: VNDA)

Yahoo! Inc. (YHOO) bear call spread

Yahoo, Microsoft to begin their Web ad partnership