Monday's Options Report: IR, XME, Medco, ESRX, XLF, LDK Solar, NOV

Rebecca Engmann Darst co-authored this article.

(IR) - This morning’s news that diversified industrial company Ingersoll-Rand will acquire air conditioner maker Trane in a $10 billion transaction designed to expand its footprint in the climate control segment confirmed a flurry of bullish option activity and a massive upswell in implied volatility that we observed in Trane late on Friday afternoon. This morning, Ingersoll Rand shares are 7.5% lower at $45.49, and its options are trading at about 6 times the average volume, with about 7,200 lots in play. Nearly 10% of this volume was tied up in January 55 calls, which sold off as the value of the position deteriorated 66%. A similar level of activity was observed in puts at the 42.50 strike, which could imply traders looking to lock in a 42.50 selling price for Ingersoll-Rand shares as the company digests its acquisition target. Implied volatility remains elevated at 35.5% - that a 22% premium on the historic reading, suggesting that the full implications of the Trane acquisition haven’t yet been fully factored into Ingersoll-Rand’s current share price, at least in the view of option traders.

(XME) – SPDR S&P Metals & Mining ETF saw its share price decline 1.4% to stand at $67.00 ahead of lunchtime. Options volume of 20,000 compared to existing open interest of 78,448 contracts meant that the options activity showed up within our market scanner. The activity was focused in two specific areas, both in the March contract. The vast majority of the existing open interest exists on the put side of this contract at the 50 strike, where the option delta is 9%, and the 70 strike, where the 53% delta already indicates that options are in-the-money. The activity piques our curiosity. First of all the 70 strike puts have now traded 10,000 volume for the second day in a row and it appears that an investor is buying puts and so taking protective action against global slowdown. The ETF holds shares in material companies such as Freeport McMoRan and Alcoa, along with energy companies including Nucor and Consol Energy. A glance at the charts shows us that this ETF shows the share price in a healthy uptrend and its shares just traded an all-time peak above $70 before starting to recoil. The second piece of action was at the much lower strike 50 line, where the delta indicates a less than one-in-ten chance that shares will fall that far by expiration. It appears that a seller is closing an old position. Given the relatively light open interest and the similar trade size here, we’d conclude that this is one investor rolling out of one position and into a more realistic strike given the fact that materials and energy-type companies have remained relatively unharmed despite the recent credit crisis.

(MHS) – Medco Health Solutions – Elsewhere, we were interested to observe sizable relative gains in two separate companies in the pharmacy benefits management space – an obscurish-sounding market segment that has nonetheless garnered a fair share of positive analyst attention in recent weeks as a solid defensive play. Medco, the company behind the country’s biggest mail-order pharmacy, hit our market scanners this morning thanks to an increase in trading volume to 5.5 times the daily average. This occurred as its shares traded 1.4% lower at $99.70. Today’s uptick in volume appears tied to deep-in-the-money call spread activity in the January contract, where about 11,000 lots were bought in calls at the 75 strike at a price of $25 apiece, against the sale of 10,000 lots at the 90 strike, which commanded premiums up about 10.50. Traders oftentimes turn to deep-in-the-money calls like this as a proxy for the actual stock, which in the case of Medco has enjoyed an almost interrupted bull run for the entirety of 2007 – even during the worst of the Indian Summer equity-market selloffs. Its share price started the year trading at around the $53 level and is now just under $100 as open interest shows bullish calls outnumbering bearish puts by a factor of around 1.4.

(ESRX) – Express Scripts – We observed a similar uptick in volume from another pharmacy benefits manager, St. Louis-based Express Scripts, whose options are trading at 4.6 times the average rate against a marginal .67% gain for its share price to $71.10. Calls are outmoving puts by nearly 15 to 1, with long positions in the December 65 calls trading within the bounds of existing open interest, but fresh short positions in calls at the January 75 strike and February 65 strike implying trader confidence in a decline below those levels into the New Year.

(XLF) – Financial Select Sector SPDR - With major indices trading lower at the noon hour, it was particularly noteworthy to register a .34% gain in the value of the financial sector ETF to $29.45 – this even despite a new spate of bank downgrades by analysts at Citigroup. With nearly 63,000 lots in play the XLF is one of the day’s most active option families according to our market scanners, with 1.8 puts in motion for every call. Puts at the December 29 strike appeared to sell off heavily at bargain premiums of 7.5%, while January puts at the 28 strike traded to the middle of the market on slightly higher premiums of 92 cents. A look at the delta on this put shows current premiums reflecting a 30% probability that this position will land profitably by January’s expiry.

(LDK) – LDK Solar –A repeat performer in our option volume scanners in recent weeks, China-based LDK saw a massive upsurge in volume this morning after the maker of multicrystalline solar wafers confirmed that an internal investigation of its silicon inventory reports had found no discrepancies or financial irregularities as alleged by its former financial controller. LDK is due to report Q3 earnings on Wednesday. Today its shares are trading at a 20% premium from Friday’s levels at $68.12, with some 54,000 option contracts in play – equivalent to 30% of its total open interest. Twice as many calls are moving as puts this morning, but these are trading in comparable measure to buyers and sellers, primarily in the December contract at strikes of 60, 70 and 80.

(NOV) - National Oilwell Varco – One of today’s M&A movers, shares in the buyer of Grant Prideco are trading 9% lower this morning at $70.30 as option traders put some 36,500 lots in play, making it one of the most active tickers to appear on our market scanners this morning. Of note here is fresh buying in December puts at strikes of 65 and 70, suggesting continued downside for National Oilwell Varco’s share price in the waning days of the December contract. Calls at the December 75 strike traded to buyers and sellers. Calls outweigh puts in the open interest stakes by a factor of 1.7.

VIX – CBOE Volatility Index – We continue to notice that market volatility remains timid despite a hefty slip in the S&P 500 index Monday. The global backdrop for stocks appears weak and there is no shortage of negative sentiment weighing on traders’ minds as they step into the office. The Nikkei led overnight Asian declines with a plus-2% slump, while U.S. traded emerging market ETFs are amongst Monday’s biggest losers. Brazil (EWZ) is lower by 3.4%, Taiwan (EWT), Australia (EWA) and Hong Kong (EWH) are all down 3.4%, while China (FXI) is also down 2.7%. Yet we note that the problematic Select Sector SPDR Financial (XLF) is now higher on the day at $29.47. To us this is the heart of the matter and only when financial stocks recover, will the broad market be able to do so also. Perhaps today’s light gain in the VIX is also explained by this fact. In the December contract, it appears that a 22.5 straddle might be in play in the VIX where gross premium is 1.6. In order for a seller of volatility to retain that entire premium the VIX index must expire within a range of 20.9 and 24.10 by Friday’s expiration. With the turnaround in financials today, Goldman’s earnings Tuesday and a clearer take on the success of the initial Fed auction of $20 billion aimed at clearing out the logjam in the money market, the potential for a market rally is possibly larger than the threat to a weaker stock market and hence an upside for volatility, which in recent weeks has failed to catch fire on broad market declines. Elsewhere, heaviest options activity is apparent in the January 30 calls where 1,700 contracts have traded. In the February calls at the 22.5 strike around 8,000 lots have traded.