Options Update: SanDisk Call Volume Swells on Toshiba Buyout Rumors

The shares of flash-memory maker SanDisk (SNDK | Quote | Chart | News | PowerRating) are inexplicably up more than 20% so far today.

There is a clear lack of major headline news for the company, though a report on the Dow Jones Newswire hints that the stock's spike could be due to rumors circulating on Wall Street that Toshiba could be interested in acquiring the firm. However, neither SanDisk or Toshiba were immediately available for comment, the Newswire reported.

As usual, options traders are like kids in a candy store when these types of rumors hit the Street. Today's investment vehicle of choice is naturally SNDK calls, with more than 18,000 of these bullishly oriented options crossing the tape so far. What's more, this activity has outstripped the stock's average daily call volume by nearly 6 to 1 and placed the shares on our Intraday Volume Explosion List. However, it was the roughly 5,200 SNDK December 10 calls that caught my eye today.

The Anatomy of a SanDisk Call Position

Diving into the options data, I was once again surprised to find that nearly all of the more than 5,200 contracts that changed hands at SNDK's December 10 call appeared to have been sold. If you read yesterday's Options Update, then you might remember that we saw similar activity for Akamai Technologies (AKAM). Open interest at this front-month option totals 5,673 contracts; however, indicating that this activity could be the closure of existing positions since volume has not exceeded open interest. Remember that a call-sell position is similar to a put-sell, except that the trader needs the shares to remain below the sold call through expiration in order to keep the premium received. It seems unlikely that traders would be entering such a neutral-to-bearish position on SNDK if rumors of a buyout are circulating on Wall Street, but let's take a closer look at a call-selling strategy for the sake of argument.

Perusing the volume chart above, a block of 120 December 10 SNDK calls traded at the bid price of $0.35 at 10:07 a.m. Eastern time, netting the trader a total credit of $4,200 -- ($0.35 * 100)*120 = $4,200. As noted above, a call-sell trader keeps the premium received on the trade as long as the underlying shares remain below the sold strike through expiration, which, in this case, is December 19, 2008.

Assuming that we are looking at call-selling activity, the investor is indicating 1 of 2 things: that he expects SNDK to remain below $10 per share through expiration, or that he wishes to sell the stock at $10 per share. In today's trading, the stock has rallied more than 18%, but has met with resistance in the 8.50-9 region. Let's see if the stock's technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

From a purely technical standpoint, the prospects for a sold December 10 call look extremely good. The shares have plunged more than 80% so far in 2008, as the company struggles to deal with falling prices for its core flash memory business. Recently, SNDK has rebounded from support near the 5 level, but short-term resistance at its declining 10-day and 20-day moving averages had held the shares in check before today's surge on buyout rumors. Still, the shares face stiff overhead resistance in the 8.50-9 region, with an additional hurdle lurking at the round-number 10 level.

The Sentiment Drivers

The stock's sentiment indicators are also aligned positively for today's call-selling example. Specifically, the stock's Schaeffer's put/call open interest ratio (SOIR) of 0.29 indicates that calls more than triple puts among near-term options. Furthermore, this ratio ranks below 86% of all those taken during the past year.

Additionally, data from the International Securities Exchange and the Chicago Board Options Exchange indicates that the ratio of puts bought to open versus calls bought to open during the past 10 trading sessions is higher than 70% of such readings taken in the prior 52 weeks. This rising optimism on an under performing stock has bearish implications from a contrarian perspective.

The Verdict?

As I stated in yesterday's edition of Options Update, I'm not a big fan of call selling. The rumors of a potential buyout by Toshiba complicate the situation even further. If the position is covered (i.e. you own enough SNDK shares to cover the sold options), then entering today's trading example could potentially limit your profit if SNDK is purchased for more than $10 per share. On the other hand, if the Toshiba rumor proves false, then a sold December 10 call would seem like a pretty safe bet. However, with the level of speculation involved, there is a considerable amount of risk surrounding such a trade - even more so if you are selling naked calls to enter the position.

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Copyright Schaeffer's Investment Research. www.schaeffersresearch.com.