Tuesday's Options Report: Bear Stearns, Lehman, Citigroup, Tellabs, Shanda

Traders instinctively know when to reach for the ripcord these days. When a day starts with an investment bank downgrading its peers the writing is pretty much already on the wall. The Merrill Lynch downgrade of shares at Lehman Brothers and Bear Stearns was largely based on the view that, given what has gone before, the outlook no longer looks particularly rosy. Today’s Case-Schiller U.S. National Home Price Index added to the pile-on, showing the severest decline in median U.S. home price in the entire 20-year history of the index, and strong indication that prices have yet to bottom out. And the confidence of the U.S. consumer has eroded to its lowest in a year on concerns that jobs may take a hit in the continuing downward churn from the subprime mortgage crisis.

Call it a self-feeding spiral, but options traders pounced on opportunities across financial markets to parlay their respective views.

BSC – With historic volatility on shares at Bear Stearns already running at around 70 percent, it appears that strangle sellers in the September contract at the 105 and 110 strikes are positioning for Bear’s share price to remain within the bracket between $90.50 and $124.50 before expiration judging by premiums received at both strikes. Shares dropped by around 2 percent Tuesday to stand at $109.72. Meanwhile it appears that some investors share the same view as Merrill Lynch. Heavy call option volume was apparent at the September 135 strike where some 7,788 calls appear to have largely trade to the ‘bid’ indicating eager sellers. The delta of just 7 percent infers that traders see a current low probability that shares will rally by the 23 percent to reach that strike.

LEH – Lehman Brothers shares were hit twice as hard when they slid 4.7 percent in response to today’s downgrade, falling to $55.02. That in itself is a little surprising given the fact that the Merrill Lynch report couched its view that Bear Stearns was certainly at the heart of the mortgage storm and that Lehman was well managed and had greater global diversification. Options implied volatility running at 62 percent compares to historic volatility in the underlying shares at 72 percent. In the September contract the action was based at strikes either side of the at-the-money strike, while call activity in October was split between the 55 and 65 strikes, where it appears that a bullish call spread is being placed at 3.95. That would imply an investor who bought the strategy is looking for maximum gains of 6.05 should Lehman’s shares rally to $65 before October’s expiry. In the last few sessions there has been a serious build in put open interest between the 50 and 65 strikes. At the lower strike open interest on bear positions rose from 14,000 to 25,600 lots while puts open interest at the 55 strike almost doubled to 17,400 lots.

C- Citigroup saw its shares neutralized by analysts at Merrill today. Shares declined by 2.4 percent to $46.65 while puts out traded calls 1.16 times. The October and December 45 puts were most popular as defense against a further deterioration in the climate for money center banks. Merrill’s note pointed out that it preferred the prospects for JPM in the current climate, but still, shares there fell by the same degree. Clearly investors see this as perhaps a first wave of downgrades or the onset of deteriorating news for financial companies.

NEM – Newmont Mining. We noted late yesterday that for no apparent reason call options in Newmont Mining were well sought after leading to especially heavy traffic at the December 45 line. Today, currently unsubstantiated rumors have emerged that Canadian miner, Barrick Gold Corp, will buy Newmont. According to today’s price action, with shares of the buyer down by 3 percent those of the alleged victim are higher by 4.3 percent today to stand at $42.22, the rumor must be true!! Although call option volume in the Dec 45 calls is again in evidence, options traders are taking this rumor more seriously in the nearby September contract where the 43.5 and 45 calls have traded on respective volume of 14,000 and 24,000 lots. Implied volatility has been notched up around one quarter to 39.9 percent in response to the pressure on call demand. The Sep 45 calls trading at 0.80 have risen by 433 percent today. Although the chance of call options at the Sep 47.5 strike, which have risen threefold today, landing in the money is just 14 percent according to current options pricing. Given the surge in demand for Newmont options, the right to buy shares in the stock have traded six times as much as the rights to sell shares in the company today.

VIX - Options traders seem to have taken advantage of a weaker volatility reading over the last week by adding substantial positions that would protect their portfolios should financial markets wobble once more. In the September contract, we noted increases in open interest readings on September call positions during the last five trading sessions through yesterday’s data. Call positioning at the 20 strike rose 25 percent to 75,288. At the 25 strike open interest has risen 44 percent to 115,068 while at the 30 strike open interest has jumped 62 percent to 64,722 contracts. Finally, given the fact that the peak value of the VIX as market sentiment hit rock bottom last week was at 37.21, open interest at the 35 call strike in September has ballooned 12,936 to 55,538 for a 348 percent increase.

This morning, the VIX is showing a 9 percent escalation at 24.76. Front-month positioning in index options saw traders favor strikes as high as the 32.50 call, where more than 3,200 lots traded on premiums of $1.15. Heaviest volume was concentrated at the at-the-money September 25 call, where nearly 7,000 lots traded at a premium price of $3.00. A buyer of this strike is banking on a spike up to 28 within the coming weeks. An additional 12,500 lots were logged in the October 27.50 calls. Put-side positioning has been minimal, with 1,800 lots trading in the September 20 puts almost as an afterthought.

TLAB - A 2.6 percent decline in share prices to $10.24 is providing the backdrop for a twofold increase in option volume in Tellabs (TLAB) today. Traffic in excess of 10,000 lots in the September 12.50 calls were logged to the middle of the market at a dime apiece, but we speculate that the trader in this case may have been closing out an existing position and rolling over to the same strike in the October contract, where we can ascertain that 11,000 fresh long positions were opened at $0.20 apiece. Implied volatility, while elevated at 51.5%, is actually about 14% below the level of price swings historically seen in this ticker. The company, which makes, markets and services voice telecom systems, saw its share price surge last month on acquisition chatter. Tellabs shares have lagged behind both the S&P 500 index and its subordinate information technology index for the year to date.

WEN – Option volume picked up to seven times their average volume against a 3 percent gain in share prices to $33.02, following this morning’s news that Wendy’s International (WEN) has granted billionaire minority shareholder Nelson Peltz access to its books and struck a confidentiality agreement, amid reports that Peltz may offer $37-41 per share to acquire the fast food chain in full. Today’s volume of nearly 20,000 option contracts represents about a fifth of Wendy’s total open positioning, and is almost entirely concentrated in the calls. Of note here is the absence of significant front-month positioning – instead, option traders are gravitating toward the December 35 and 40 calls, well within the theoretical range of Peltz’s offer. Buying is heavy at the former strike, with heaviest volume at premiums of $2.00-$2.10. The December 40 calls have traded mostly to the middle of the market.

SNDA- Call-option interest in the US-traded ADR of Shanda Interactive Entertainment (SNDA) is high for a second consecutive day, after the company reported 6 percent growth in Q2 sales. The company, which recently undertook a massive restructuring designed to reposition it as China’s largest entertainment company and leverage its access to the online games market, reportedly the country’s largest source of online revenues. Today’s near-10,000 active contracts are equal to about 12 percent of Shanda’s total open interest. Four times as many calls are moving as puts, with 3,500 contracts trading to the middle of the market in the September 30 calls. Following the earnings report, option implied volatility beat a hasty retreat, pulling back by a quarter overnight to stand at 52 percent.