Options Update: Volume Soars on Lennar Following Minkow Fraud Allegations

Shares of Lennar Corp.
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have plunged more than 19% so far today, after a letter surfaced on the Internet questioning many of the home builder’s financial practices.

Specifically, Barry Minkow’s fraud discovery.net posted several concerns regarding business practices at Lennar, including a joint venture between the company and a private developer to build a high-end housing project and golf course in California. Analysts questioned the accuracy of Minkow’s report, but said that Lennar, the U.S.’s second-largest home builder, doesn’t provide a lot of information about such dealings, making it difficult to completely dismiss all of the allegations.

Lennar shares were off as much as 28% at one point in the session, prompting a veritable flood of options activity on both the call and the put side of the coin. Naturally, the stock makes an appearance on our Intraday Volume Explosion List, with call volume outpacing the daily average by more than 15 to 1, and put activity soaring to more than 17 times LEN’s average daily trading volume. Digging into this flood of options reveals that the hotly contested January 2009 10 strike has received the lion’s share of today’s volume.

Lennar option volume details

The Anatomy of Lennar Call and Put Positions

Looking over the chart above, you can see that there is practically no selling activity to be found. With volume at both the January 2009 10 call and put easily outstripping open interest at these front-month options, it is likely that we are looking at a wealth of new bought-to-open positions on LEN.

Since puts appear to be the most popular today, let’s start with this bearish activity. Specifically, a block of 390 January 2009 10 LEN puts traded at the ask price of $1.85 at 10:39 a.m. Eastern time. The total outlay for this position would be $72,150 — ($1.85 * 100)*390 = $72,150. For this trade to reach breakeven, LEN would need to fall about 12% to $8.15 per share from the stock’s current trading range near $9.36 before the options expire on Jan. 16. The maximum loss on this position is limited to the initial investment of $72,150.

Turning to today’s call activity, a block of 500 January 2009 10 LEN calls traded at the ask price of $0.85 at 10:43 a.m. Eastern time. The total outlay for this position would be $42,500 — ($0.85 * 100)*500 = $42,500. For this trade to reach breakeven, LEN would need to rally about 16% to $10.85 per share from the stock’s current trading range before January expiration. The maximum loss on this position is limited to the initial investment of $42,500.

Today’s plunge could be devastating for LEN, as it has placed the stock below key technical support levels. However, the shares are still up more than 13% since the beginning of 2009, despite the smackdown. So, do the stock’s sentiment and technical backdrops favor the call or the put side? Let’s take a closer look at these indicators to find out.

Getting Technical

Lennar’s technical performance during the past several months has been stellar. From a short-term perspective, the stock has surged more than 184% since mid-November, as investors snatched up LEN shares following a string of government interventions and Federal Reserve moves to support the struggling credit and housing markets. Despite today’s selling spree, the shares have maintained support at their 10-day and 20-day moving averages, which have helped usher LEN higher since November. This technical strength clearly works against a January 2009 10 put.

Daily chart of Lennar since October 2008 with 10-day and 20-day moving averages

On the other hand, the shares are now trading south of formerly staunch resistance in the 10-10.50 region. Remember, the January 2009 10 call trader needs LEN to rally past this area in order to realize a profit. Further complicating matters is the presence of the equity’s 20-week moving average at the 10 level. LEN has not closed a week above this trendline since late September 2008.

Weekly chart of Lennar since April 2008 with 20-week moving average

The Sentiment Drivers

The sentiment front favors bullish contrarian investors, especially if LEN manages to close above its 10-day and 20-day moving averages this afternoon. Currently, more than 21% of the stock’s float is sold short, while 8 of the 10 analysts following LEN rate the shares a “hold” or worse. Should the security push past today’s fraud bombshell, we could see valuation-related upgrades from Wall Street – much like the one J.P. Morgan handed out yesterday. Such a development could pull bargain hunters off the sidelines, thus increasing the buying pressure on LEN shares.

Sentiment indicators for Lennar

The Verdict?

Given the data above, a call position on LEN looks like a potentially lucrative option play. Personally, I would opt for the February or May 10 call, just to give myself more time to take advantage of a potential rally in the security. Keep in mind that the January 2009 10 call expires at the end of next week, leaving little time for LEN to retake the aforementioned technical hurdles. As for the put side of the argument, it only makes sense if Minkow’s accusations are actually proven true – a process that would also favor a February or May option.

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