A hospital company drowning in liabilities just reported good results. Now a trader is using options to position for a comeback.
Here’s a breakdown of the strategy detected yesterday afternoon in Community Health (CYH):
- 20,000 September 4 puts were sold for $0.72.
- 20,000 September 6 calls were bought for $0.87.
Short puts generate income and oblige the seller to buy stock if a certain level is breached. In this case, it’s $4.
Long calls fix the price where a security can be purchased, in this case $6. Both halves of the trade will profit from a rally and lose money to the downside.
The position is essentially a surrogate for owning 2 million shares, but with an initial outlay of just $0.15 per share. It will generate huge leverage on a breakout through $6, or massive losses on a drop through $4.
CYH rose 7.61 percent to $4.95 yesterday, and was up 25 percent in February. Most of the move occurred on February 21 after profits stabilized and higher admissions were forecast.
Management also got easier terms from creditors — a big plus for a company whose credit rating is deep in “junk status.” Now it’s looking to capitalize on the better sentiment by issuing new bonds to refinance older debt.
Short interest could also be a factor because bets against the stock account for roughly one-quarter of its float. If bears are forced to “cover,” it can potentially result in a “squeeze” higher.
Valuation watchers may also be interested in CYH because it trades at less than 0.1 times revenue, less than one-tenth the ratio for better-capitalized peers like HCA (HCA).
The large trade pushed overall options volume to about 20 times CYH’s daily average in the last month.