The steel stock that has the shorts and options traders on edge

Key points

• Cleveland-Cliffs reports earnings on Oct. 19 with short interest near 14%.
• Its July report triggered a nearly 16% one-day jump, about double the average move.
• Options traders expect a repeat, pushing up short-term implied volatility.

Cleveland-Cliffs is set to report earnings on Oct. 19, and options traders are preparing for a large price move. The steel company's stock jumped nearly 16% in one day after its July quarterly report, almost double its long-term average move of just over 8%.

Short interest in the stock is close to 14%, and the CEO has a reputation for confronting skeptics. According to the article, he has said he likes to boil them "like frogs" and that they are "messing with the wrong guy."

Options market braces for volatility

Short-term implied volatility has been bid up sharply as traders fear a repeat of July's swing. The article describes a "strangle-swap," also called a "double-diagonal" spread, which sells a shorter-dated strangle and buys a longer-dated one to define risk.

The approach relies on the gap in implied volatility decay between the November options being sold and the January options being bought. Once the earnings report passes on the 19th, the binary uncertainty disappears and November implied volatility is expected to collapse, a move known as "vol crush."

messing with the wrong guy

— Cleveland-Cliffs CEO

Profit range and defined risk

The trade is most profitable if Cleveland-Cliffs stays between $11 and $17 after the report. In that case, the November short strangle loses value quickly and can be bought back cheaply or left to expire worthless, leaving the trader with a long January 10/18 strangle.

The strategy loses money if the stock repeats or exceeds its July move, because the short strikes at 11/17 are narrower than the long strikes at 10/18. Maximum downside and upside risk are each $1.24 per contract, or $124, based on the spread width plus the net debit.