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Smithfield Foods Option Traders Brace for a Pullback

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SFD has seen a rare spike in put buying.

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The shares of Smithfield Foods, Inc. (NYSE:SFD) are in the black this afternoon, with the stock approaching nine-month highs. However, despite outperforming the S&P 500 Index (INDEXSP:.INX) by 13.5 percentage points during the past couple of months, SFD remains plagued by pessimism. In fact, it looks like options traders may be bracing for a post-earnings pullback for the packaged meat producer.

At last check, SFD has seen close to 3,900 puts change hands -- about 56 times its average intraday put volume, and more than three times the number of SFD calls exchanged. Garnering the most attention has been the out-of-the-money December 19 put, which has seen more than 2,200 contracts traded on open interest of fewer than 150 contracts, pointing to an influx of new positions. What's more, 97% of the front-month puts have crossed at the ask price, hinting at buyer-driven volume.

By purchasing the puts to open, the buyers have one of two motives: to profit from a significant short-term plunge, or to "insure" a long stock position. In the case of the former, the buyers are hoping SFD breaches the $18.85 level (strike minus volume-weighted average price of $0.15) within the next few weeks. However, even if the stock embarks on a post-earnings plummet, downside could be limited thanks to its 200-day moving average, currently lingering in the $18.25 neighborhood.

In the case of the latter, the protective put buyers are shareholders above all else. Or, in simpler terms, their primary goal is still for SFD to extend its recent uptrend; the purchase of the puts merely locks in an acceptable price at which to sell their SFD shares, should the stock take a hit before December options expire.

Whatever the motive, today's affinity for puts is a divergence from the norm. On the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), speculators have bought to open more than four SFD calls for every put during the past couple of weeks. Furthermore, the stock's 10-day call/put volume ratio of 4.51 stands higher than 82% of all other readings of the past year, suggesting option buyers have initiated bullish bets over bearish at a faster-than-usual clip.

As a result, the equity's Schaeffer's put/call open interest ratio (SOIR) stands at 0.42, indicating that calls more than double puts among options with a shelf-life of three months or less. Plus, this ratio sits just three percentage points from a 52-week low, implying that near-term options players have rarely been more call-heavy during the past year.

Elsewhere on the Street, though, skepticism prevails. Short interest increased 7.4% during the past month, and now represents nearly seven sessions' worth of pent-up buying demand, at SFD's average pace of trading. In the same vein, just three out of 10 analysts consider the security worthy of a "buy" or better rating, and the stock's average 12-month price target of $22.60 represents a discount to SFD's current share price.

Should the company unveil stronger-than-expected earnings tomorrow morning, this sentiment backdrop leaves the door open for a short-squeeze situation, upgrades, or price-target hikes to fuel additional gains.

At last look, SFD has added 1.8% to explore the $22.94 level.

This article by Andrea Kramer was originally published on Schaeffer's Investment Research.

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