Thursday's Options Report: BEA Systems, Merrill, XLF, Microsoft, RTH, SMH, ACLI, & SLE

by: Interactive Brokers

BEAS –Earlier today BEA Systems deftly floated a $21 per share counteroffer for a possible buyout bid, having spurned a $17-per-share unsolicited price from Oracle that some called “generous.” Despite the confident counteroffer, no “prom alternates” appear to be in the picture for BEA Systems. Shares in the company inched .40% today, with volume equivalent to about 13% of its options in play. A look at the volume distribution shows traders far from resolute about the price outcome for BEA’s coquettish bidding game. While buying in the November 17.50 puts and selling in the January 17.50 calls implies a withering move for BEA shares in the coming months, call buying was observed at the same strike in December. The market is still pricing in a better than 50/50 chance that current price levels will hold, but in terms of option price action, traders aren’t venturing north of the at-the-money strike.

MER - The market continues to ruminate on yesterday’s staggering Merrill Lynch write-down. Reflecting with the benefit of a day’s hindsight, the news was significant to the larger health of the market for three key reasons – first, CEO Stan O’Neil’s admission of fallibility with regard to risk management is dispiriting news not just for his firm, but for his field mates in the brokerage game. Secondly, it effectively tossed cold water on the idea that credit market writedowns might be cordoned off within Q3 – Merrill’s third-quarter reporting period ended September 30, so yesterday’s bottom-heavy report suggests that the company was in dire straits as recently as a few weeks ago. (Brokerage peers Goldman Sachs, Lehman Brothers and Morgan Stanley reported Q3 earnings for the period ending August 31). Finally, it drew attention to how quickly and mercilessly asset valuations can and very possibly will change – Merrill’s estimated loss ballooned from $4.5 billion at the October 5 projected to nearly $8 billion when the hour of reckoning arrived. Merrill’s leveraged woes have cast new scrutiny on the efficacy of a recent Treasury-led initiative to shore up nearly $100 billion in illiquid structured investment vehicles (SIV’s) backed by rotten subprime debt and keep them off the balance sheets (and therefore inured to writedowns) at banks like Citigroup.

Merrill shares are down 2.3% today at $61.77 and its options are moving on a fairly liquid volume of 66,400 contracts. Call holders in the January contract closed out positions at the 65 strike today, while puts at the 60 level in December and January contracts traded to the middle of the market on heightened premiums. The volume distribution here suggests traders are hedging against ominous eventualities in Q4 – as opposed to just short-term share price turbulence for the rest of the month. The bearish tone of this positioning isn’t completely reflected in the total put/call ratio, which shows a comparable number of open call to put positions.

XLF - Meanwhile, the Financial Select SPDR continues to sit at August lows. Implied volatility at 30% compares with a 21% historic reading, and after yesterday’s late-day session showed a proclivity to at-the-money straddle buying in the November contract – a strong indication of near-term volatility for the beleaguered financials – today’s volume shows a build in the January 34 puts, possibly indicative of traders looking to hedge against the prospect of further asset writedowns and credit market stiffness.

MSFT – Earlier today, Microsoft pipped rival bellwether Google to the post of a coveted share in social networking site Facebook. The hammer dropped at $240 million on Microsoft’s winning bid, which confers a 1.6% minority stake in the company. Microsoft shares are 1.76% higher at $31.80 as of the noon hour, and its options are extremely liquid, with more than 233,000 contracts in play. Buyers and sellers have flocked to the November 30 and 32.50 calls and puts. The same strikes in the January calls have also been heavily trafficked – a sign of measured bullishness on the upshot for Microsoft’s share price. The bidding war has left a discernible mark on implied volatility – a week ago the implied vol reading stood at 25% - it’s now approaching 30%.

RTH – Shares in Retail HOLDRs gained around 1% to $98.35 this morning while implied options volatility continued to subside by around 15% to stand at 23%. That fits neatly with the apparent sale of straddle combinations in the November contract. Traders sold the 95 put series and the 100 call series either side of the current share price taking in combined premium of 2.5. In doing so investors have a cushion between share prices of $92.50 and $102.50 between which they make money. Between the two strike prices they get to keep the entire premium, while as prices approach the breakeven boundaries profits erode to nil. The options implied volatility on this ETF is substantially below that on the largest fund components. Options on WalMart, for example trade at 28%, Home Depot options are priced at 33% and Target options carry implied volatility of 38%. Finally, Lowe’s options are priced at 38% volatility. Between them, these stocks carry up to 46% of the weight of this fund. Because the fund has a diverse number of holdings, its implied reading of volatility is lower than that on individual stocks, but investors might keep their eyes peeled for signs of options positioning on individual stocks heading into November.

SMH – The 2.4% slide in Semiconductor HOLDRs shares today to $33.63 was also accompanied by a rise in put trading on the ETF. Investors sought downside protection in the November series at the 32.5 strike buying close to 4,00o lots and paying premiums between 0.42-0.47. Breakeven would occur at a share price below $32.03. Investors also took a more bearish medium-term perspective on the sector by selling call options in the January contract at out-of-the-money strikes as high as 35 and 37.5 strikes. In order to reach the upper strike within three months shares in the fund would need to rally by 11.5% from current prices. Implied volatility in those calls is running at around 28%, which compares to historic volatility on the shares of around 21.5%.

ACLI - Shares in American Commercial Lines, a barge operator whose activities have diversified in recent years to include towboats, barges and drydock capabilities, dropped 25% today on a Q3 earnings miss. Options are trading at 11 times the average rate, and with put-side premiums richer on the precipitous drop in shares, it appears that a trader took profit on existing positions in the January 25 and March 15 puts and wrote fresh puts at the March 15 line.

SLE - Shares in consumer goods giant Sara Lee (SLE), whose brand lineup includes the likes of Ballpark Franks and Hillshire Farms, are trading .68% higher at $16.21. Given today’s unhurried share price action, we were particularly intrigued by a bearish play in the November 12.50 puts that was sufficient to sent its option volume to 10 times the daily average. The 5,000 lots bought in the November 12.50 puts would look for share prices to dip to levels not seen in more than 7 years.