Wednesday's Options Report: MCO, MER, XLF, QLGC, CBS, CFC, AMZN

by: Interactive Brokers

MCO - Shares in credit ratings giant Moody’s (NYSE:MCO) are down nearly 3% this morning to $46.01 after its Q3 profits report gapped below analyst estimates and the company shrunk year-end guidance on back of continuing credit market weakness. The company has taken flack along with arch-rival Standard & Poor’s for its complicity in giving inflated credit ratings to debt instruments backed by subprime loans.  With options trading at nearly 8 times the average volume, traders are positioning for further downside in Moody’s share price – moderate in the front month, and more pronounced into the New Year. This was expressed through put spread activity in the November contract, where traders sold puts at the 45 strike for around $1.65 apiece to defray the cost of buying puts at the 55 mark for $8.90. Action in the January contract showed traders buying puts, with more than 20,000 lots bought at the 40 strike for $1.90. A move below $40 would put Moody’s shares at levels not seen since mid-2005. This is a company trading 40% below its 52-week high of $75.85 set back in the salad days of February.

MER – Merrill Lynch reported its first quarterly loss in six years today and astounded the street with an enormous write down of $7.9 billion in mortgage related debt. Shares reacted negatively but only went into freefall following a downgrade from a ratings agency. According to comments from the investment bank, “management failed to accurately assess potential risk and mitigation strategies were inaccurate.”  There was a huge shortfall on revenues and the street is confused as to whether there may be further write downs going forward. It seems that investors are wondering whether this is the tip of the iceberg for both Merrill and other banks. By 11:30 its shares were down by more than 6% at $62.97 marking a further 52-week low. According to our reading of the put/call ratio there are 1.7 times as many puts in play today as there are calls. The negative reaction sent equity indexes reeling in response. Implied volatility rose by almost 5% to stand at 43.5% on Merrill options indicating a lessening conviction on the direction of its share price. While we noted a surge in call buying at the November 75 strike Tuesday, those calls shed 70% of their premium today slipping to just 0.15.

But it might not be all bad news according to option trading patterns where it appears that investors are creating put spreads to define the potential trading range going forward. The activity in the November and January 55, 60 and 62.5 puts indicates some selling, which is likely against freshly established long positions in the 65 puts. It would seem that investors are taking today’s disaster with a grain of salt. The November puts at strikes as low as 55 remained popular for a second day while volume at the 65 strike accounted for one-in-eight of today’s overall volume. Premiums at that strike rose by two-thirds offering investors the right to sell shares for $65 prior to expiration. The increase in premium lowers the share price at which such protection kicks in, reading $61 today in comparison to $62.35 on Tuesday.

XLF – Financial sector SPDR shares put in the weakest share price since August 16 today thanks to fallout from the Merrill report. Merrill Lynch comprises 2.5% of the value of this ETF. Shares slipped to $32.10 before rebounding but at noon stood 2.1% lower at $32.51. The put/call ratio was marginally more bearish on the fund at 1.77 today. Heaviest volume was at the November at-the-money put strikes of 32 and 33 where 19,000 lots traded in each series. In the December contract it appears that an investor dumped 10,000 calls at 0.11 in the 38 strike. As shares put in a poor showing and put volume increased, option implied volatility jumped 14.2% to stand at 32%. That compares to a historic reading of 19% on the underlying share price, but clearly a fresh wave of concern is washing up on the financial shoreline.

QLGC - Shares in Qlogic (QLGC), which producers storage components for the telecommunication industry, are bucking the broader market trend with a 9.35% gain for shares on the day to $14.74. Redoubled gains for the company come a day after its Q3 earnings report that showed falling profits, but EPS that beat street estimates. The current share price reflects a 28% gain on its 52-week low of $11.46, though its shares have traded as high as $22.94. Option traders heretofore have favored a glass-half-full view of its share price prospects, given the fact that 4.6 calls are open for every put. Today’s option volume is nearly 5 times the daily average, and it looks like traders are availing themselves of a 100% increase in premiums by taking profits in the January 15 and 17.50 calls. Calls in the November contract were bought at the more circumspect strikes of 12.50 and 15.

CBS - For a second consecutive day, options in media conglomerate CBS are trading at multiples of the average daily volume. Yesterday the company announced an executive restructuring in its radio division, and two days ago it hit its 52-week low – shares have come slightly off that low, but are trading nearly 2% below yesterday’s close at $28.90. Today’s option action shows traders selling the January 27.50/32.50 strangle – a move that typically implies a decline in price volatility and rangebound price action. Whether or not this dropdown in volatility can be attributed to the cancellation of “Viva Laughlin” we’ll leave to the armchair voters to decide. In any event, a seller of this strangle opens this transaction with a credit of $1.30 in the belief that CBS shares will remain within the range of the two strike prices. The upper strike is still 7% shy of its 52-week high, so it’s hardly a rousing vote of share price confidence.

CFC – It’s two days and counting until Countrywide Financial’s Q3 earnings report, and shares extended losses a day after the Wall Street Journal broke news of an increase in missed payments on ARM mortgages among Countrywide customers. With shares down 6% at $14.11, implied volatility shot up 16.7% overnight and now exceeds 115%. Today’s most heavily traded contract is the November 15 put, which is being bought heavily against a 40% increase in premium. Open interest on this strike has increased more than 400% over the past 5 sessions, as a desire for defense against share price erosion continues to gather pace. Elsewhere we noted pronounced volume in the January 10.0 puts, which were bought at prices around $1.00. Delta on this call indicates that the option market is pricing in about an 18% chance of Countrywide shares degenerating into junk range after the “annus horribilis” of 2007.

AMZN – So much for partying like it’s 1999. Shares in e-tailer Amazon turned tail by 15% today to $85.35 – just one day after breaching the $100 mark for the first time since ’99 – after positive Q4 guidance failed to measure up to the market’s bullish expectations. Option traders today have put more than 211,000 contracts in motion, making it one of the most liquid series on our scanner today. Despite the share price turbulence, implied volatility came off sharply – it topped out yesterday above 68%  and now stands at 46%. The reversal in share price momentum has pulled the rug out from under call-side premiums. Heaviest volume today appears in the November 95 calls, where open interest had doubled in recent sessions. A buyer of this call paid $10.90 yesterday for the greedy pleasure of watching Amazon shares join the ranks of tech-heavy overachievers. Today that call is worth just $1.23 and is selling off heavily.

VIX – CBOE Volatility index – today’s bearish tone was met with an unsurprising jump in the fear gauge, which stands 14% higher at 23.30. The popular trade remains long positioning in the November 25/30 call spread costing around 0.90. However, investors do seem to be taking long positions in both the 30 and 32.5 calls. What stands out most notably today is the lack of put trading across the board. Almost all of today’s 55,000 lot volume is to the call side. The 1.3% decline in S&P index appears to have generated few optimists despite the two day gain for equities so far this week. The most actively traded put contract is at the December 20 strike where 3,000 lots have gone through at a price of 1.6 implying a breakeven reading for the VIX around holiday time of 18.4.