Thursday's Options Report: MRK, AZN, LEH, C, CCU, ORCL

Rebecca Engmann Darst contributed to this report

MRK – It looks like option traders are steeling themselves with long-volatility protections in anticipation of a rough ride for Merck shares this morning. Shares trading a modest .56% lower at $44.45 despite breaking news this morning that Merck’s asthma treatment, Singular, is facing an FDA for possible correlation to suicidal ideation in patients. This morning’s news came after an early morning Bloomberg story indicating that Merck and Schering-Plough are asking doctors to “ignore” the findings of January’s so-called Enhance study, which pointed to clinical shortcomings in the companies’ joint venture cholesterol drug Vytorin. A final report on Vytorin’s effectiveness is due to be presented in Chicago on Sunday.

With the news flow suggesting that Merck shares are sitting on a volatility fault line of sorts, it’s no surprise to see the implied volatility reading at 37% suggesting about 29% more price risk to Merck shares over the next month. This kind of disparity tends to drive option premiums – especially for long volatility positions like straddles and strangles – sharply higher. Despite this, a pulse check on the morning option action shows some indications that traders are buying the April 45/47.50 strangle for $2.55, a position that generates profit for the buyer with a break below $42.45 or above $50.05. While a buyer of this position isn’t expressing a preference as to the direction shares will move, we note that April 40 puts are also trading heavily on 40% higher premiums – and on a higher implied volatility level – implying that demand for protection at lower-strike puts is higher. May strangles between strikes 40 and 47.50 also appeared to attract buyers. We continue to keep an eye on the $40 puts in Merck today, representing a pivotal drop below the 52-week low. AZN – Interestingly, the announcement on Merck’s Singulair was accompanied by news that the FDA is also investigating reported suicide and behavioral links to an AstraZeneca asthma drug, Accolate. American depositary receipts of European drug giant Astra Zeneca are trading .78% higher at $37.46, but the tripling in option volume we observed early in the session shows some traders looking for a break in its share price to 5-year lows. The action, which was centered in the May contract, would seem to correlate this move with Astra Zeneca’s April 24 earnings announcement. Traders bought the May 35 puts for 90 cents apiece here. Implied volatility shows an added element of price uncertainty to Astra Zeneca’s price action – 21% more such uncertainty, in fact - over the coming month.

LEH –A case in point over the tormented impressionability the market continues to carry over the brokerage space came in the form of a 5% drop in Lehman Brothers shares to $40.60 (far out-sizing declines in the other brokerages), which coincided with a 15-bp increase in Lehman’s credit default swaps. Implied volatility in Lehman Brothers options quickly rose 23.3% to 105.9%. Overall volume bumped up to nearly 100,000 contracts in the first 90 minutes of the market, with 4 times as many puts trading as calls. Similar to what we observed with Citi above, the 10,000-lot put spread activity in the July contract that was the cause of so much early-morning ado may have been traders seeking to defray the $7.90 purchase price of the higher-strike put via the sale of puts at the 17.50 strike for $1.34. Still, the $6.56 net debit to initiate this transaction still requires a drop in Lehman prices to $33.44 – 17% below current levels – just to break even. Option traders continue to hold twice as many put positions as calls.

C –Shares and implied volatility in Citi are showing a fair amount of imperviousness given the inundation of news flowing its way since last night’s market close. Clear Channel’s successful suit for a temporary restraining order requiring a Citigroup-led consortium of banks to honor its commitment to finance a private equity takeover of the company coincided with a new round of large-cap bank downgrades. While implied volatility at 63% shows about 5% less price risk to Citigroup shares over the coming month, we were astonished to see some option traders position for a new pass at the teens for Citigroup heading into the June contract. Buying in the June 20 puts for $1.54 on volume of 20,000 lots may have been financed via the sale of twice as many out-of-the-money 12.50 puts at 23 cents apiece. Defraying the initial cost outlay in this manner would allow the trader, via an initial $1.08 debit, to realize a profit from the position with a decline in Citigroup shares below $18.92, within $1 of its 52-week low.

CCU - A temporary reprieve in the form of legal injunction from what was shaping up to be a spectacular private equity deal washout gave Clear Channel shares 9.4% of their value back to $29.44 in early trading. Implied volatility also shrunk dramatically, down 14.6% to 82.4%. While volume in the front-month remains a jumble of two-way volatility bets in the form of strangles, we did observe call-buying at the May 35 strike at around $1.50 – a position that requires another 23% upside from current share prices just to break even, still short of the original $39.20 per-share offer that remains an elusive Shangri-la for Clear Channel shares.

ORCL – Yesterday’s after-the-bell earnings miss by Oracle sent shares more than 7% lower to $19.45 as the market was dismayed by the impact of tight-fisted financial companies on new software investors. With the price of the $21 straddle in Oracle predicting as much as a $2 price move on back of the earnings, the decline in its share price has bumped the price of the straddle up to $2.85, yielding a tidy 42% profit for traders who positioned long of volatility ahead of the release. There’s much in the activity so far today to suggest that Oracle has seen the worst of the downside, and will remain respectably above its 52-week low of $17.89 over the coming months. Both sides of the $21 line continue to attract buyers, but a glut of April 19 puts sold for 45 cents suggests that some long put spreads may be going through this morning, or short strangles using the $19 put as the low bookend for the trade. In the June contract, it appears that a 9,400-lot short strangle was deployed by a trader taking the $1.00 premium in the expectation that shares will remain within a $2 range not dropping far below current levels into June.

KG –Options activity in yet another drug maker, King Pharmaceuticals, showed massive gains relative to open interest, with a 29-fold increase in trading volume. Shares in King dipped nearly 7% to $8.42, currently hovering around the 52-week low, after U.S. regulators issued a warning to the drug maker over misleading claims in promotional literature for its morphine capsule Avinza. The share price slide sparked an instantaneous gain in implied volatility by fully one-third, and sent option traders piling into long positions in April 10 puts for $1.70 and 12.50 puts for $3.60.