Options Update: Lehman Brothers Sees Massive Call and Put Volume
I have to admit that I pretty much knew I would be writing about Lehman Brothers
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PowerRating) in today’s edition of Options Update, after the buyout speculation hit the Street this morning. Options traders love unexpected volatility and LEH provided that this morning when the Korea Development Bank (KDB) announced that it was pondering a potential acquisition of the U.S. investment bank. A spokesman for KDB told Reuters, “We are studying a number of options and are open to all possibilities, which could include [buying] Lehman.”
Looking at our Intraday Volume Explosion List, it would appear that both the bulls and bears are jumping into LEH positions. Put volume on LEH numbers more than 60,000 contracts so far today, nearly quadrupling the stock’s average daily put activity, while call volume has soared to more than 75,000 contracts, more than quintupling the daily average call activity. But is was the heavy attention to the September 18 call and the October 12.50 put options that caught my eye today.
Put Selling and Call Buying
Despite the mixed nature of today’s option volume, the overall trend appears to be neutral-to-bullish for LEH. Looking at the chart below of LEH’s notable October 12.50 put (LYH VV), it would seem that most of the large blocks are crossing at the bid price, suggesting that the contracts were sold. With volume at this strike exceeding open interest, we are likely looking at the initiation of a new put sell position. Furthermore, 3 of the largest blocks trading on the same exchange, and at the same time for the same price, and I would wager that those 10:42 a.m. trades were the same position, totaling 4,200 contracts.
On the other hand, we appear to have quite a bit of bullish speculation in the options pits for LEH. Two blocks totaling 9,300 contracts traded at 10:54 a.m. at the ask, suggesting that these contracts were also purchased.
So, on one hand we have a potential put sell at the October 12.50 strike, with a total credit of $672,000, or ($1.60 * 100)*4,200 = $672,000. Remember that with a put sell, a trader would keep the entire premium as long as LEH held above the 12.50 level by expiration on October 17. (Keep in mind that these put selling calculations do not take into account any potential margin account requirements enforced by your broker.)
On the other hand, we have a potential call position bought to open at September 18 strike, with a total outlay of $1,162,500, or ($1.25 * 100)* 9,300 = $1,162,500. That is no small chunk of change! For this trade to reach breakeven, LEH would need to rally roughly 24% to $19.25 per share. We arrive at this by adding the cost of the option ($1.25) to the strike of the purchased 18 call ($1.25 + $18 = $19.25).
By entering the first trade, the hypothetical trader is looking for LEH to simply hold above the 12.50 level by the time the options expire on October 17. On the second trade, however, the trader needs LEH to rally more than 24% before the options expire on September 19. The first position is quite neutral, while the second appears to be aggressively bullish, with the trader potentially betting on an actual buyout of LEH by KDB. Let’s see if the stock’s technical picture or sentiment backdrop offer up any clues on the potential for profit from these positions…
Technically Speaking
On the technical front, it would appear that, ceteris paribus, a put seller would have the upper hand. LEH continues to be pounded by subprime, credit crunch, liquidity, and capital concerns along with the rest of the financial sector. The shares have plunged more than 79% since the beginning of 2008, pushed steadily lower by their declining 10-week and 20-week moving averages. However, the shares have found some short-term technical support in the 12.50-14 region. If this technical support could hold through mid-October, it would keep the hypothetical put sell position out of the money, allowing the trader to keep the entire premium.
As for the call buyer, there is heavy overhead resistance in the 18-20 region. This area has become even more crowded for LEH recently, as resistance at its 10-week trendline has descended into the region. The stock has not closed a week above this moving average since early May. Without the potential for a buyout by KDB, LEH would have little chance of extending today’s gains given the current climate on Wall Street concerning the financial stocks. For the hypothetical call position to achieve breakeven, LEH almost needs a bid from KDB in the $20-per-share range or above for the stock to rally the needed 24%.
The Sentiment Drivers
Despite its long-term downtrend, pessimism doesn’t completely blanket LEH’s sentiment backdrop. In fact, options players are extremely hopeful that a bottom is in place for the shares. Specifically, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 1.06 ranks below 96% of all those taken during the past year. This ratio indicates that options traders have been more optimistic toward LEH only 4% of the time in the past year. With investors looking feverously for a rally in the shares, it could mute any upside momentum derived from any good news the company may receive or issue. What’s more, it could exacerbate any downside moves on poor news from the firm. Basically, these high expectations support neither the purchased call nor the sold put.
Pessimism is thick in the short-selling community, as investors have reacted to the extremely poor price action in LEH shares. However, this build-up in short interest could benefit both hypothetical positions. Positive news could bait these short sellers into buying back their positions, thus pushing LEH higher. Such an event could directly benefit a call buyer, and while put sellers wouldn’t pad their pockets on the rise, it would place the sold put even deeper out of the money.
Finally, Wall Street analyst ratings are a mixed bag for LEH. According to Zacks.com, 8 of the 12 analysts following the shares rate them a “hold” or worse. While any positive developments for the company could prompt upgrades from these bears, you rarely see analyst activity surrounding a buyout event. In fact, if the shares rally above what analysts believe what a suitor would pay for LEH, the shares could be downgraded. Such an even would be troublesome to either position talked about above.
The Verdict?
Personally, I would be more comfortable with the put sell position in this case. Technical support seems solid enough to keep LEH above the 12.50 level by the October option expiration, and there are just enough sentiment factors to help buoy the shares during this timeframe. Meanwhile, it is all but necessary for the KDB or another suitor to make an offer for LEH in order for the purchased call position to rally through technical resistance and overcome the current market stigma to achieve profitability.
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