Tuesday's Options Report: UAUA, Adobe, ZGEN, NLS, KWK, WPZ, Best Buy, GS

by: Interactive Brokers

Rebecca Engmann Darst co-authored this article.

(UAUA) - One look at the stratospheric implied volatility reading in United Airlines’ parent company UAL and it’s a safe bet that option traders don’t think we’ve heard the last of the consolidation scuttle. Topping 89.4%, UAL’s implied volatility reading is 1.3 times the historic reading, and significant call volume brings to mind the massive upticks in call volume tied to M&A speculation (to wit November 24 and December 4). The immediate difference between the two aforementioned heavy call-traffic sessions and today’s activity is the gaping disparity between historic and implied volatility, which appears to be at its highest level in more than a year. This interest may be occasioned by a CNBC interview with Continental Airlines’ former CEO on Friday, who told the network after Lufthansa’s purchase of a stake in JetBlue that consolidation was “inevitable” in ending the airline industry’s boom-bust cycle, especially given the prospect $100 oil. Gordon Bethune told CNBC that 3-4 major US airlines would be “plenty,” citing a Delta takeover of United as the most obvious way to “get the ball rolling” on a further consolidation of the American industry that would might help it remain competitive on a global scale.

On the options front, United options are trading on a volume of nearly 27,000 lots – making it one of the day’s most active option families in early market action - as its shares are flat-to-lower at $34.70: a hint that the share price action hasn’t caught up with the speculative interest on the option front quite yet. Volume distribution shows what looks to us like call spread activity involving 10,000 lots between strikes 40 and 50 in the January contract. Given current premiums, a trader in this instance might control higher trade costs occasioned by elevated implied volatility by selling the 50 calls and using the $0.30 premium to defray some of the $1.22 cost associated with buying calls at the 40 strike. Delta on that 40 strike indicates the option market pricing in a slightly better than one-in-four chance that United’s share price can make the 18% liftoff from current levels to $41.22 by January’s expiry.

(NASDAQ:ADBE) – One of a number of positive earnings surprises, Adobe, the maker of Acrobat and Creative Suite 3 graphic design software, reported a bumper 21% increase in profits and offered higher-than-expected Q1 earnings guidance for 2008. Heading into the report late yesterday afternoon we noted a flurry of buying interest in the December 40/42.50 strangle, a position which cost a combined premium of $1.60 heading into the report, entered in the expectation that Adobe shares would exhibit either an upside break past $44.10 or a downside move below $38.40. This morning, Adobe shares are up 3%, within 4% of the upper breakeven on yesterday’s popular strangle combination. The 42.50 calls have sold off heavily on a volume some 9,600 lots – while we’re observing fresh positioning in the December 42.50 puts, which have sold off heavily at around $.90 in a brazenly bullish move by option traders willing to bet that Adobe shares won’t dip back below the 41.60 level before the December contract expires on Friday.

(ZGEN) – Options in ZymoGenetics courted our attentions this morning owing to a more than 7-fold increase in trading activity. The spike in trading volume was accompanied by a sudden 20.7% jump in implied volatility to 123.4. Shares in the biotech, which is a wholly-owned subsidiary of Danish-based insulin producer NovoNordisk, and creates therapeutic proteins used in drug development, are trading 5.5% lower at $12.80 in early market action. The downside move in its share price is oddly timed, considering that the company just yesterday announced that it was proceeding to Phase 2 clinical trials of its protein Interleukin 21 (IL-21), used in the treatment of patients with metastatic skin cancer. Rather than positioning for a possible promising drug in the company’s pipeline, option traders appear to be bracing for a test of the standing 52-week low by February. It appears that traders sought fresh positions in the February 10 puts, which traded to the middle of the market at around $0.90 per contract on a volume 10 times the prior open interest. Put buyers sought positions at the January 12.50 strike at around $1.50 apiece – a position supposing a break at least $11 by January’s expiry.

(NYSE:NLS) – Share price and option activity in Nautilus, the maker of fitness machines including the popular BowFlex and StairMaster lines, is showing evidence of bullish spotting in the market today. With its shares up 7.3% before noon at $6.01, we observed an increase in option trading activity to 4 times the normal level, accompanied by a 43.3% increase in implied volatility to 109.5%. A look at option activity shows traders seeking fresh long positions in January 7.50 calls at premiums around $0.30 apiece. Nautilus shares last traded around $7.50 l in October – a pit stop on a ruinous 56.6% decline for its share price in a year that began with its shares trading at the $13 level. If option action is any reliable indication, the company may be in for a bit much-needed rush of adrenaline after the New Year.

(NYSE:KWK) – Our market scanners picked up a 5-fold increase in trading volume for QuickSilver Resources. Shares in this Fort Worth, Texas-based company, which is involved in the exploration and production of onshore natural gas using “unconventional” reserves such as coal bed methane and shale gas, are trading more than 16% higher at $57.47 after the company forecast higher-than-expected production and capital expenditures for the coming year. While the announcement elicited some investment banks to raise their target on QuickSilver’s share price, option traders picked the moment to take profit in December 55 calls, where today’s $2.70 premium represents a 2600% increase from yesterday, and seek fresh positions in December 55 calls, where the 1,391-lot volume represents more than 7 times the prior open interest at this strike. QuickSilver shares have delivered 46% returns over the past year, outdistancing the S&P 400 Energy Index by 15.1%.

(NYSE:WPZ) – The well-timed, well-executed closure of an existing strangle combination appears to be the culprit behind a 30-fold increase in option trading volume observed in Williams Partners L.P.., another player in the natural gas exploration and production space. Shares in the company are trading about .53% lower at $37.28 this morning and a look at the 31.4% implied volatility reading shows only a slightly increased expectation of share price movement above and beyond the 29.7% degree of volatility that its shares have shown historically. A trader may have looked to take advantage of an outlook for less volatile share price movement by closing out a 30,000 lot position at the March 35/40 strangle, a position bought around November 20 for a combined premium of $2.65, which appears to have been closed out for $3.00 today.

(NYSE:BBY) – Shares in Best Buy Co., the country’s biggest consumer electronics seller, reported a 52% increase in net income for the third quarter, and a 17% rise in sales, besting street estimates and comparing favorably to sector peers including Circuit City. Despite an early boon for its share price, Best Buy shares are down 2.6% at $49.80 as of the noon hour, but the near 99,000 lots in play make it one of the most liquid option families according to our scanner. The level of volume equals about 11% of its open interest in play following a more than 23% pullback in implied volatility to 31%. The fact that its implied volatility reading now rates below the 33.7% historic reading is a fair hint that the option market is comfortable with the current share price level. Puts are outmoving calls by a factor of 1.5, with traffic localized in the December 50 puts – possibly the closing out of positions as premiums eroded 20% after the bullish earnings report.

(NYSE:GS) – Shares in Goldman Sachs are trading 5% lower at $198 after the company’s before-the-bell Q3 earnings report surpassed street estimates and flaunted the investment bank’s ability to hedge deftly despite challenging credit market conditions, sending stock futures higher. The turnaround in its share price action appears to be the result of investors taking to heart the bank’s warning of continued market challenges into 2008. With more than 112,000 options in play this morning, Goldman Sachs is one of the day’s most heavily trafficked tickers according to our scanners, and the action is notable for a wave of selling pressure in December 210 and 220 calls, as the value of this position eroded more than 80% from yesterday’s levels. Options traders had priced in about a 6% up-or-down move heading into the report, and early action suggests that this will be met from the downside.