The past few months have not been pleasant for shareholders of Melco Crown Entertainment (NASDAQ:MLCO). After Melco's spectacular run from around $9 in July of 2012 to its all-time high of over $45 earlier this year, shareholders have endured a more than 27% pullback in the past several months. Despite the painful correction, many reasons remain for shareholders to remain optimistic about the future of the company. The past few days have provided yet another reason: someone out there is betting big on Melco.
What can options activity tell you about a stock?
On March 13, I wrote about unusual options trading in World Wrestling Entertainment (NYSE:WWE). At the time, shares of WWE stock were trading at around $30, and everything was looking rosy for shareholders. The new WWE Network had just launched, the legendary Hulk Hogan had just signed up with the company again in time for Wrestlemania, and shareholders were drooling over the new TV deal the company was negotiating for its weekly shows Raw and Smackdown. WWE's Chief Strategy and Financial Officer George Barrios even compared the company's pending TV deal to Nascar's $820 million annual TV deal with Fox and NBC of Comcast. Since WWE's expiring contract was for only about $100 million, comparing the new deal to Nascar's $800 million deal made it seem as if the sky was the limit for WWE stock.
However, amid all the optimism, I noticed something strange happening with WWE options. The open interest in each of the October 2014 put strike prices was less than 200. That is except for one: the $17.50 puts had an open interest of 7,535! With the share price at around $30 at the time, someone had a more than $1 million bet that WWE would be trading under $17.50 (a drop of over 40%) in about seven months!
As crazy as it sounded to me at the time, after a disappointing $200 million TV deal and lackluster WWE Network launch, WWE is now trading at around $11. And those $17.50 October puts that were worth $1.2 million in March? As of today they would be worth over $5.3 million!
What is recent Melco options trading telling us?
I laid out my case for why I believe Melco is a buy a few weeks ago here on Motley Fool. The last month has brought a revolving door of bad news for the company, including shrinking odds that Japan will legalize gambling, China cracking down on money laundering in Macau, and monthly gaming growth in Macau growing slower than anticipated. However, despite the battering from the bad news, I still believe my case for owning Melco for the long run holds up just fine. And apparently someone with deep pockets agrees with me.
Over the past several days, volume has been over 14,000 in January 2016 Melco calls at a $39.70 strike price.
As of today, there is an open interest of 12,720 for these calls. At today's price, that represents a $7.6 million bet that Melco will be trading at or above $40 by 2016. This is by no means a guarantee, but some big money is clearly confident that the recent pullback in Melco will be long forgotten in a couple of years.
The option-trading crystal ball
I'm not a sophisticated options trader. In fact, I can count the number of options trades I've made in my life on my two hands. However, I often look at options activity to tell me something about what options traders with deep pockets seem to think about the outlook for a stock. Of course, wealthy, savvy personal investors and institutions can be just as wrong about stock predictions as small retail investors like me.
Wayne Duggan is the author of Beating Wall Street with Common Sense and the developer of tradingcommonsense.com. Wayne Duggan owns shares of Melco Crown Entertainment. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.