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By David Russell

A big legal battle is brewing in the hospital sector, and the bears are having a field day. Our tracking systems detected a surge of activity in Community Health Systems (NYSE:CYH) and Tenet Healthcare (NYSE:THC), which are both plunging on heavy stock volume.

The activity results from a lawsuit by THC that claims CYH overbilled Medicare, a bizarre twist in a takeover battle that began in December when THC found itself the target of a hostile buyout offer. Since then, CYH has attempted to take control of the smaller company's board.

Today's lawsuit appears to be the most serious attempt by THC so far to block the merger and is designed to undermine the expected synergies of the tie-up. Despite the allegations, government officials haven't filed any charges against CYH.

Activity is more bearish in CYH, the defendant in the lawsuit. The shares plunged 30 percent to $28.07 as investors aggressively bought the April 30 puts, driving premiums from $0.50 early in the session to as high as $3. More than 4,800 contracts traded against no existing open interest.

Overall option volume in the name was 24 times greater than average, with puts accounting for 73 percent of the total.

THC is down 13 percent to $6.54, but option traders are taking a more sanguine view by selling the May 7 puts. That reflects a belief that downside is limited in the stock. More than 48,000 contracts trade in THC, which is about 11 times the typical amount.

Source: Bears Slam Hospital Stocks on Legal Fight