International Paper Co. (IP) – Management yesterday took a chainsaw to an outstanding debt covenant reducing its obligations and turning sentiment on the stock positive. It would appear that an earlier decision to reduce its dividend payout, which created negative share price action at the time, was a wise one from the Tennessee-based paper-company. While the move sparked a jump in implied options volatility as the stock reached record lows, the benefits are quickly being displayed. The company recently announced the re-jig of a loan agreement in which the company used some of its cash to pay down the overall burden and in so doing has allayed liquidity fears. Shares added 13% to stand at $7.16 today and so well above the recent $3.93 low. Options traders meanwhile looked for further gains in coming weeks perhaps in expectation that the revamped financial structure might be more appealing to investors. Call options expiring in April and July offering buying rights on the shares at a fixed price of $7.50 were heavily trafficked today with volume at both strikes exceeding established bullish positions. Investors bought 14,800 calls expiring in April for 75 cents and more than 10,000 calls for 1.40 expiring in July. At 103% implied volatility seems rather high given management’s balance sheet tune-up.
CBOE Volatility Index – One investor placed a large long butterfly combination in the May options in a trade that banks on implied volatility standing still, at least by the time expiration arrives. The VIX index is a little lower today at a reading of 42.86, while investors reservedly test the warmer waters surrounding the recent improvement in sentiment towards financial stocks in particular. The combination involved the purchase of 20,000 calls at each of the May 35 and 55 strike prices, while the investor sold twice as many calls at the central 45 strike for a net cost of around 2.40 per contract. This investor is largely at odds with the school of thought that takes the Bernanke line and also those who see a turnaround in financials as the first sign of a spring thaw for stocks. Those investors would by definition expect lower volatility to accompany higher share prices, while the butterfly trader expects a volatility hangover through early summer. The position would make the most if the VIX settled at a reading of 45 at May’s expiration in which case the investor would make maximum gains of 7.60 per contract.
Oracle Corporation (ORCL) – Shares of the software company are off by about 1% to stand at $14.75. ORCL’s target share price and estimates for the 2010 fiscal year were revised lower by Jeffries in a report today. Oracle’s target price was cut from $20 to $18 and its earnings per share for 2010 were revised to $1.46 from $1.55. Despite the revision, today’s report did cite the ORCL’s ability to “cut costs aggressively” and hinted at potential M&A opportunities for the firm in the second half of 2009. One option trader took advantage of current pessimism by getting bullish in the January 2010 contract. Hoping for a turnaround into next year, this investor purchased 8,300 calls at the January 20 strike price for 70 cents apiece. The pure call buying suggests that he is looking for unlimited upside, though shares will need to rally by 40% from the current price in order to reach the breakeven point at $20.70 by expiration. The calls are only half of the story as the same individual also initiated a put spread set to expire in January 2010. At the January 15 strike price 8,250 puts were bought for 2.55 each, while at the 12.5 strike 8,250 puts were sold for 1.35 per contract. The net cost of the spread amounts to 1.20 and yields a maximum possible profit – should shares decline below $15 by next year – of 1.30 pocketed if the share price settles at $12.50. The establishment of the put spread alongside the bullish call buying suggests that this trader is willing to accept the negative news surrounding Oracle, although it seems that he would much prefer the software company to blow through analyst expectations by next year.
Cogo Group, Inc. (COGO) – The provider of module design solutions has experienced a 2.5% decline in shares to $6.50 after disappointing earnings were released yesterday. COGO reported its highest annual revenue in history at $287 million for 2008, but its fourth quarter EPS of just 2 cents missed the 18 cent estimate for the quarter by a wide margin. The company edged onto our ‘hot by options volume’ market scanner after one investor sold 12,500 calls at the April 7.5 strike price for a 15 cent premium. While the calls traded to the middle of the market we believe they are likely to have been sold. The bearish sentiment evident from this investor’s sale is likely shared by other traders who must be wondering why the soaring revenues reported have not fattened COGO’s bottom line.
Freds, Inc. (FRED) – One option trader took a pop at this discount general store by selling upside calls expiring in August. The company appears similar to Family Dollar in that it serves low, middle and fixed income customers and stocks 12,000 frequently purchased items. Family Dollar is one of a handful of companies that have performed well as the economic slump has deepened. Shares in Freds are almost 5% higher at $10.88 and we think what we’re seeing is evidence of a covered call strategy that would deliver about 50% gains on the stock alone should the share price advance to the 15.0 strike calls, which were sold today for around 45 cents. The strategy is mildly bullish and given the fact that Freds options are rarely visited, this trade sticks out like the proverbial sore thumb. Regardless of whether or not the share price does advance, the option seller retains the premium and the caveat here is that at expiration the investor must deliver shares, if the call buyer exercises his right to acquire stock.