Thursday's Options Report: Merrill, C, UA, MON, OMX

Rebecca Engmann Darst co-authored this article.

(MER) - A look at yesterday’s then-at-the-money January 55 straddle in Merrill Lynch showed option traders pricing in a moderate 4% up-or-down price move ahead of earnings. Merrill’s share price had surged 4% yesterday in a sort of last-minute morale booster for new top-man John Thain. The raw numbers came in as a bit of a shock, with losses of $10 billion capping off a period that saw Merrill’s share price depreciate 25%. As Thain seeks to “sell the loss” (as CNBC’s Charlie Gasparino put it), diverting the market’s attention away from its massive writedown and toward its forward earnings power. Still, the magnitude of today’s 8% decline in Merrill shares to $50.65 (double what front-month volatility was predicting yesterday) shows the market isn’t firmly convinced that even ironman Thain can keep further writedowns at bay. Incidentally, the January 55 straddle that traded for $2.75 yesterday is $4.10 today – a profit margin of almost 50%. We also observed heavy buying and selling activity in January 50 puts, which convey the right to sell Merrill shares for $50 on Friday – given the 75-cent premium on this position, this would require a move below $49.25, still $1.75 above the 52-week low it set back on January 9.

VIX – Merrill earnings and Congressional testimony by Fed chairman Ben Bernanke that pulled no punches in describing the state of the economy pushed the Volatility Index past 25, where it has not managed to pull off a close since last Tuesday. Heading into today’s session, despite increasing confirmation of recessionary activity and the largely southbound momentum we’ve seen in major indices, the index was still trading just 5% above its average of the past 6 months and hadn’t ventured to 30 since November 12. Despite this it was February 30 calls in the VIX that continued to attract attention from buyers today, with almost 1 in 3 active contracts trading at that strike this afternoon. Calls at the February 32.50 and 35 strikes also drew brisk offers to buy, the latter on volume of more than 10,000 contracts.

(C) – Shares in Citigroup retreated 2.5% today to $25.57, etching out 52-week-lows as it goes along. More than 200,000 options in Citigroup had traded by early afternoon, with volume split evenly between puts and calls. Puts at the January 25 strike gained 25% in value this afternon but still managed to attract buyers, while calls at the January 27.50 strike traded on a similar volume of 29,000-plus lots to both buyers and sellers, despite being worth only 4 cents. Incidentally, current option prices reflect a better than 1-in-4 chance that Citi can break below $27.50 by tomorrow’s expiration.

(UA) – Options in athletic wear maker Under Armour Inc. are trading at 7 times the normal level according to our “Hot by Options Volume” scanner, against the backdrop of a 16.4% decline in its share price to $35.89. The selloff represents a drop to 10% below its prior 52-week low. Catalyst for the selloff appears to be concerns raised by analysts at Wachovia over the costs of an ad campaign Under Armour is set to run during next month’s Super Bowl. Talk of bloated marketing budgets may have further spooked investors already nervous about companies in the vulnerable consumer discretionary/retail apparel space. The selloff sent implied volatility in UA options 23% higher to more than 101% - 1.6 times the historic reading. Traders took fast advantage of the selloff by shorting calls at the January 40 strike on volume exceeding its prior open interest, pocketing the 25-cent premium in confidence that its shares can’t rebound by tomorrow. January puts at strikes of 35 and 40 also attracted fresh buyers, given massive vitamin-shots in put-side premiums. The cost of securing the right to sell Under Armour shares for $40 tomorrow is 1366% more expensive today than it was yesterday, and at $4.40 it would require a further 50-cent decline in Under Armour’s share price from afternoon levels just to break even.

(MON) –Shares in Monsanto, the world’s biggest seed producer and maker of “Roundup” weed killer and various genetically engineered cropseeds, dropped more than 10% in afternoon trading to $101.00. Earlier today analysts at UBS warned that the company may fall short of street expectations when it reports earnings on August 2. Monsanto shares set a 52-week high of $129.28 on Tuesday. The downgrade sent implied volatility massively higher, with the 69.8% reading showing option traders pricing in a likelihood of 24% more volatility from Monsanto than its shares have shown historically. Again, with January options set to expire tomorrow, we noted fresh buying in puts at strikes of 95 and 100. We also observed fresh call buying at the January 105 strike, possibly in strangle combinations with the aforementioned puts, but certainly a strong indication that traders feel the $1.40 premium is worth the price of capturing a volatile move in Monsanto shares in the final hours of the contract.

(OMX) – A rare bright spot on an otherwise somber market day, shares in office supplies retailer Officemax advanced 2.5% to $19.48 on no apparent news catalyst. This development represents a bounce back from the 52-week low of $17.12 set for Officemax shares back on January 9, capping off a 52 week period in which its shares were stripped of 60% of their value. Implied volatility at 50.8% has shown little change since September. With that in mind we were interested to see traders position in non-directional volatility plays in the time-value-rich January 2009 contract. The activity here represented more than 12 times the normal level of volume observed in this ticker. It appears that a trader bought long into the 15/20 strangle, a position which at $4.37 costs 22% of the current share price. A trader in this case is looking for a pickup in volatility that would make the $4.37 position even richer, generating profits if Officemax shares break above $24.37 or below $10.63.