Wednesday's Options Report: Macy's, Yahoo, Merrill, Safeway, Humana, Celestica

M – Macy's (M) – One of the more active takeover rumors of late has focused on shares at Macy's, where no one has been able to pin the tail on the donkey. But overnight Women's Wear Daily has reported that a buyout is set to be finalized in the next few days coming from Kohlberg Kravis Roberts & Co., along with Goldman Sachs Group Inc. According to the story the deal will be struck at $24 billion or $52.00 per share. Shares rose 10 percent on Wednesday to stand at $44.08 – still well short of the apparent bargain price.

July call option buyers gave the story sufficient emphasis as despite the fact that the series expires at the weekend. Heaviest volume was seen at the monied $40 strike (10,400 lots) while it looks like volatility positions in the 42.5/45 and 45/47.5 strangles may have placed judging by comparable put side volume.

Further out in the August contract the most heavily traded contract was at the 45.0 strike with 12,700 lots trading between prices of 1.8 and 3.1. At the high end there buyers need Macy's shares to trade above $48.10 to start making money. The volume at the 50.0 strike at 7,700 lots implied that shares need to trade through $51.05 for call buyers to break even.

Implied volatility on options prices rose by 12 percent. For traders looking at the August 45.0 straddle, used to play narrowing and expansion of options volatilities, the current price of 5.0 compares to a closing price of 6.3 when shares closed at $40.03. The current straddle price implies that shares will range between $40.00 and $50.00 precisely between now and August expiration. Naturally if there was some official announcement to this deal we'd likely see implied volatility slide as the bid share price becomes the focus. During the last week call buyers have extended positions centered on the three strikes around and including the 45 strike by 16 percent to 45,314 contracts. At the same time similar put positioning has risen by 905 lots to stand at just 8,821 contracts.

XLF – Financial Select Sector SPDR (XLF) – Share prices in financial issues are down almost twice as hard as the broad market indexes Wednesday. The XLF is down 1.9 percent at $35.98 and we can't blame shares at Bear Stearns, which have come away lightly from a report in last night's WSJ that the subprime focused hedge funds are all but worthless. Today options trading continues to be dominated by put positioning with 2.6 trading for each call today.

Implied volatility in the XLF has gained 17.2 percent overnight, leaving options trading at almost two-thirds more volatility than is typical of the ETF. It seems that an investor maybe taking the view that this is set to decline heading forward using the December series at the 38 strike. Volume of 13,500 in both puts and calls indicates a straddle being placed at a price of 3.8 with implied volatility reading around 18.9 percent there. If this is the case a straddle seller would want the XLF share price to remain within $34.20 and $41.80 by expiration. Maximum potential profits of 3.8 per contract would occur at the strike price.

Lower down in the December 33 and 34 strike puts, volume was lofty at 4,100 and 12,500 contracts respectively. Naked put purchases would offer protection to buyers in these cases if the XLF share price fell to $32.15 and $33.10 respectively.

In the August contract 37,600 puts traded at the 36 strike for a premium of 0.90 implying protection below a share price of $35.10, which would mark just another 2.2 percent share price fall.

MER - Barely a day after news of its 31 percent Q2 profit growth was received by the market with fanfare, shares in Merrill Lynch (MER) are down nearly 3 percent in early trading today, at $83.67. The downtick follows an analyst downgrade, reported by MarketWatch this morning, of the top five U.S. brokerages, citing concerns that the demise of two Bear Stearns hedge funds with leveraged exposure to subprime mortgages may be evidence of a “systemic” problem with far-reaching detrimental effects for the brokerage sector. About 51,000 Merrill Lynch option contracts have traded hands this morning, with implied volatility at 34.5 percent, against 25 percent historical volatility for Merrill Lynch shares. While call volume is outpacing put volume by factor of more than 1.5, this may be attributed to the more than 17,000 lots going through on the August 90 call. These contracts, which traded on existing open interest, went predominantly to the bid side on sharply reduced premiums. Put-side premiums are sharply elevated today, as is the ratio of total open put positions to calls in Merrill Lynch.

YHOO - Options in Yahoo! (YHOO) continue to be sought after by volatility traders, despite a 4.4 percent shave in share prices this morning, which were selling $26.33 at first report. Some 131,865 options have moved in early trading, with 1.5 calls trading for every put. Highest volume has been concentrated in the August series, at the 30.0 strike, where more than 30,000 lots moved on premiums discounted some 60 percent from yesterday's levels. Straddle activity in the August series appears centered at the 25.0 strike, where 4,000 lots have moved on the call side and 4,500 have moved on the put side. Put-side premiums are elevated throughout the rest of the foreseeable options calendar, indicating a heightened downside risk premium for Yahoo! in the forward-looking options market – not surprising in light of yesterday's sober earnings report. Implied volatility on these options is currently gauged at 32.3 percent, against 26.7 percent historical volatility for Yahoo! shares.

SWY - The day after news of a tentative collective wage agreement between 65,000 union-organized California grocery workers and three major grocery chains, options volume in Safeway (SWY) has seen a steep pickup this morning. Volume in early trading was nearly 17 times the daily average, with options traffic equivalent to a quarter of Safeway's 37,450 total option interest in play. Shares are up more than 4 percent in early trading, currently selling at $36.50. Premiums on the August 40.0 call contract are up 450 percent this morning. Some 5,367 lots have changed hands on this contract, which for a face value of $0.50 confers upon the holder the right to buy 100 shares of Safeway stock at the contract's August expiry for $40.00 each. Implied volatility has also seen a huge pickup, with investors factoring in 21 percent more anticipated fluctuation in share prices today than they did yesterday. Implied volatility in Safeway options now stands at 34.9 percent.

HUM - Better-than-expected Q2 earnings and a scaling-up of its year-end EPS guidance was rewarded with a 9 percent gain for shares in Humana (HUM), one of the nation's leading managed health care providers, particularly in the Medicare segment. The jump in share prices sparked a similar pickup in premiums and volume, which quickly moved to more than five times the daily average, with volume equivalent to 13 percent of Humana's total option interest circulating in early trading. Twice as many calls have moved as puts so far today, and we note here the brashly confident price distribution in strike prices. Investors are paying 100% more today for call options in the January '08 series at the 80.0 strike price. With the contract selling today at $1.60, a break-even on that call would presuppose a move higher in Humana shares to $81.60 by the contract's expiry six months from now – almost a $14.00 price upside move from today's prices. In fact, nearly 1,500 lots have traded on that scenario today.

ZMH - Yesterday's dramatic pickup in options volume and share prices at Zimmer Holdings (ZMH) was broadly attributed to takeover chatter – but no names named in the way of possible buyers. This morning, Zimmer shares are down roughly half a percentage point in early trading, at $87.94. Options volume remains respectable, at 6,600 contracts this morning – equivalent to about 11 percent of its total open interest. Twice as many calls are moving as puts, though risk premiums are favoring the put side – indicative of a possible anticipated pullback in share prices as chatter subsides. Volume in excess of 1,200 lots has moved at the near-expiry July 90.0 call this morning, while more than 1,000 have moved at the same strike in the August calls series.

VIX - The CBOE VIX index [VIX] wasted no time before rallying again today by 6.9% percent to 16.72. The Dow Jones industrial average lost 0.63 percent to 13,884.90. The S&P 500 declined by 0.67 percent to 1,538.82, while the Nasdaq composite index dropped 1.09 percentage point this morning to 2,682.84.

Premiums for protection against accelerating stock index activity rose Wednesday as seen in the August VIX series. Both the 20 and 25 strikes were active with 18,000 and 22,300 contracts trading respectively. The 20 calls traded at 0.80 marking an increase of one-third on yesterday's closing price, while the 0.35 premium paid on the higher strike price is 40 percent higher than Tuesday's close. There has been a huge build in investor interest in these two strikes in the last week along with the mid-22.5 strike. Total open interest in all three has surged from 117,000 contracts to 284,000 contracts for a boost of 142 percent.

Weakness in the financial sector ETF indicates to us that investors expect higher volatility going forward and using leveraged options contracts on the CBOE VIX index is a smart way to neutralize a lot of risk. Some investors may be spreading positions using the upper 25 calls to sell in order to lower premium costs. We haven't seen the VIX at that level for many years. But then again the index had been coasting quietly under the radar screen between 10-13 percent earlier this year. It looks like the giant is awakening.

CLS - A noteworthy transaction involving options in Celestica (CLS) went through this morning, following an analyst downgrade of its share price target from $6.40 to $6.00. With shares down half a percentage point in early trading at $6.24, Celestica options volume gained massively following a transaction involving 10,000 lots in the forward-looking January '09 7.50 straddle, where 10,000 lots traded to the bid side, and a fresh position in an equal number of puts at the same strike went to the ask side. The resulting 20,000-lot volume was equal to more than a third of Celestica's outstanding option interest.