Options Update: Option Players Try to Capitalize on Lehman Brothers

• July 11, 2008
• Mark Fightmaster

Leh Down, Lehman

Yesterday, Lehman Brothers
provided us with the news driving our focus stock. Today, LEH has become the focus stock … let’s see what’s up.

The investment bank plummeted out of the gates, pushing the stock to a 9-year low as concerns grew about LEH’s future. The firm stated that hard-to-value assets now make up a higher percentage of its overall assets. Yesterday, LEH noted in a Securities and Exchange Commission filing that its Level 3 assets (comprised of mortgage and asset-backed securities) fell slightly, to about $41.3 billion from $42 billion. LEH added that its total assets fell by 8%. Although many analysts and experts think LEH could go the way of the bear – Bear Stearns, to be exact (rumors abound about Barclays purchasing LEH) – others aren’t quite as bearish. Keefe, Bruyette & Woods analyst Lauren Smith believes that LEH’s liquidity pool continues to be strong and rates the shares at “market perform” with a $33 price target.

As a result of today’s news, LEH has slipped nearly 20%. This action has kick-started heavy option activity, which is what caught my eye today.

According to today’s Intraday Volume Explosion List, LEH is the subject of heavy put and call action in the option pits. In fact, put activity on LEH eclipses that of Fannie Mae (FNM). A total of 130,881 put contracts have crossed the tape on LEH, which is nearly 4 times the average daily total. A great deal of this activity is centered on LEH’s July 15 put (LYH SC), with volume of 33,460 contracts. As for the calls, the July 17.50 call (LYH GW) has absorbed a majority of the call activity with volume of 15,782. Of course, this is roughly 27% of the 59,649 total call contracts that have transacted on LEH.

Action on LYH SC was rather mixed. Of the sizeable (translation: 4-digit-plus) transactions that crossed, the action was nearly evenly split between crossing at the bid and at the ask. This suggests that option players are both buying and selling these contracts. Moreover, a good portion of the action is marked as some part of a spread. It certainly seems that option speculators are setting the 15 level as a rather significant line of demarcation. As for the calls, there were no significant transactions that counted. There were 2 nice-sized blocks, but 1 was cancelled and 1 was late.

LEH-ing in Wait

According to Zacks, LEH’s brokerage brethren show a little sympathy. The struggling stockrater earns 2 “strong buys,” 2 “buys,” and 8 “holds.” I’m not a big fan of this configuration, mainly because the stock is flat-out struggling. This bullish bunch could eventually issue downgrades, which could push LEH shares lower still.

As for option players, I am really concerned about the sentiment. LEH’s Schaeffer’s put/call open interest ratio (SOIR) of 1.50 may be inherently bearish … but it ranks in the 39th percentile. This ranking suggests that this 1.50 reading is actually lower than 61% of the past year’s worth of readings. Moreover, the SOIR hints that the readings could grow more bearish and drag the stock lower. I really don’t understand this low reading, unless option players are buying into the belief that financials have hit a bottom.

LEH-ing Low

Quite honestly, I wouldn’t mind seeing the bullish sentiment – if there was some hint that the stock was going to rebound. That 2-letter word if carries quite a bit of weight, as I just don’t see a reason to believe that there is a bounce in the near future. That 15 level has not been able to stand up to LEH’s 4-week drop of 17% and it could now act as resistance.

Let’s not think that LEH’s slide is contained by a 4-week period, a 26-week period (it has shed 64%), a year-to-date period (70% drop), or even 52 weeks (a 72% fall). The poor performance dates back to January 2007, when the stock was trading in the lower-80 region. This trend is now a long-term trend that has placed LEH below many, many, many (I need to stress that word) layers of potential resistance.

That monthly chart is disturbing, but the optimism that LEH receives from option players and (to an extent) analysts is the most disturbing. Do they know something that we don’t?

The Verdict? The problem with trying to call a bottom to the problems the financial sector is having is that the ramifications from poor timing could be costly. I am not ready to call a bottom on the problems plaguing financials, and neither is Todd Salamone. In this week’s Monday Morning Outlook, Mr. Salamone reiterated our bearish outlook on financials. The main reason for being bearish toward financials is the optimism facing the entire sector. The Select Sector Financials SPDR Fund (XLF) continues to face heavy optimism despite a 4-week pullback of 14%. XLF’s SOIR is at a 52-week low despite this drop … color me confused.

If you have any questions or comments, make sure to email me. I will do my best to answer your question or address your concern.

Want more of my thoughts on the market? Don’t like my views and want to see those of my colleagues Andrea, Elizabeth, Jocelynn, Colleen, or Joe? Make sure to check out our Schaeffer’s Daily Market Blog section throughout the trading day.

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