Today’s tickers: BSC, JPM, XBD, SPX, LEH, UBS, C, NEM, ABX, RIO, SHPGY, NTC
BSC – With option volume in Bear Stearns continuing to mushroom to 7 and a half times the normal level as shares posted a 46% decline to $30.70, speculation is rising that the broken brokerage will be forced into a hasty marriage over the weekend – possibly with JP Morgan Chase, which agreed this morning to borrow funds from the Fed’s discount window and lend them to Bear Stearns to keep the bank operationally solvent for the coming weeks. Latest reports indicate that JP Morgan Chase is working closely with Bear Stearns on “permanent financing or other alternatives,” but the market is skeptical as to whether a bailout by JP Morgan Chase or any other major financier would follow through in a premium to holders of common stock given the brokerage’s sizable financial woes and the heavy concentration of senior debt, which would benefit before shareholders from any weekend buyout. Having said that, even a very slight premium to the current depressed market value could result in as much as a $10 gain for Bear Stearns shares subsequent to a buyout. We think this may account for the high level of fresh volume we’re seeing in front-month Bear Stearns calls at strikes 35, 40, 45, 50 and 55.
JPM – Implied volatility in Bear Stearns’ “deliverer,” JP Morgan Chase saw a 23% spike in implied volatility this afternoon to 67.7% as shares closed 4% lower at $36.55. The more than 86,000 lots trading in JP Morgan Chase this afternoon traded about twice as often to calls as to puts, with call buying at the March 37.50 strike and two-way traffic at the 40 strike. It’s interesting to note the level of reserve that option traders are showing the would-be white knight, given the level of put buying in the April contract at strikes of 30 and 32.50.
XBD – The volatility setup ahead of next week’s raft of brokerage earnings reports has driven volatility to a 72% premium on the historic reading in the Securities Broker/Dealer index. Open interest on this ETF is small, numbering only about 13,000 contracts, but the level of volume we’re observing today amounts to more than half of this positioning. Given that puts at the March 150 were sold for $3.00 and calls at the 175 strike were bought for $1.70, it looks like the volume here is a reverse collar, used to protect a short position in the ETF or elsewhere in the brokerage space from an unexpected reversal higher by selling a put and buying a call to protect the short position in the underlying.
SPX – While the flat consumer price index gave investors an early buzz on Friday morning ahead of the market opening, futures quickly sold off as news of Bear Stearns’ woes caused liquidity to become scarce. The first half hour of trading saw the most violent price movements in SPX pushing volatility levels north of 30%, up more than 12% at midday. Such gyrations in the futures markets had the ripple affect of making it very difficult for SPX market makers to hedge their options positions, which led to much wider options markets for smaller size than we normally see.
IB’s Block Execution Desk manager, Kevin Fischer noted that for the first time in quite some time, elevated volatility was impacting one of the deepest liquidity pools used by investors to hedge portfolio risk. Mr. Fischer remarked, “SPX index spreads that normally carry a bid/ask spread of $0.30 have been quoted up to $1.00 wide at times.” Outright options were as much as $2.00 wide for size due to the increased delta and volatility risk compared to spread strategies. “On a day like this, market makers are less willing to take on large size. Rather, they will trade smaller pieces and make sure that they can hedge before taking another bite,” noted Mr. Fischer.
LEH – The most acute contagion from the liquidity disease afflicting Bear Stearns today appears to be festering in Lehman Brothers, which joins fellow brokerages in reporting earnings next week. New jitters about Lehman’s financial health came in the form of news in its credit default swaps, which reportedly widened by 65 basis points this morning in the immediate wake of the Bear Stearns news. The development sent implied volatility in Lehman Brothers options more than 90% higher to 134.99%, with heavy put buying in the March contract at strikes 35, 40 and 45 as the mad rush for protection against further downside drama in its share price appears more or less unmitigated today. Puts outtraded calls today by a factor of 4.4 to 1.
UBS – Meanwhile, earlier today, Swiss bank behemoth UBS affirmed that will soon release the findings of an internal probe into its exposure to US-based subprime mortgages, averting a legal battle with a shareholder group that had demanded an independent, external probe of its $18.4 billion. UBS has thus far sustained more subprime-damage than any other European bank. Shares in UBS closed 8.4% to $27.74 this afternoon, as news of the imminent airing of its subprime laundry sent implied volatility in its options as much as 70% higher, signalling a 65% higher risk premium to UBS shares over the next month than they have shown historically. Put volume in UBS, meanwhile, dwarfed call volume by 12 to 1 today with heavy volume in put strikes 25 and 30 in the March, April and June contracts. With UBS shares setting a new 52-week low today, the current option activity shows a slightly better than 1-in-4 chance that UBS finishes below the $25 line by next Thursday, and a better than 1-in-3 chance that the downside will persist to that point in April, implying a slow unraveling in its share price over the coming months as the market prepares for UBS’ dubious “reveal.”
C –Citi’s Implied volatility spiked 33% on the Bear Stearns-led market meltdown. With shares in Citigroup down 6% to $19.81, earlier today we observed significant volumes going through at the March 20 straddle, where traders appeared to favor long-positions at this at-the-money line. The $2.00 price of this position covers the buyer in the event of an upside recovery to $22.00 or down below $18.00.
NEM – Despite a sliding equity market investors are once again seeking solace in gold and mining shares on Friday. The 200-point loss for the Dow industrials helped push the price of gold back above $1,000 per ounce throughout the morning. Newmont Mining was one of several mining stocks whose option activity was among the greatest today. While shares traded higher during the morning, the trend reversed in the afternoon to close .28% in the red at $53.63. Option traders looked to the March 52.0, 55.0 and 60.0 call options banking on an imminent continuation of the move higher. Meanwhile open interest continues to build in the June 55 call series where some 3,000 contracts traded at around a premium of $4.50 indicating a breakeven price for the shares at $59.50.
ABX – American Barrick Gold Corp shares rallied this morning and were able to cobble together a .36% higher close to $53.24 this afternoon. Option implied volatility at 48% remained higher than the historic display of share price volatility by some 17%. In comments to CNBC Barrick’s CEO noted that financial market volatility was boosting demand and therefore the price of gold. He also noted that his company wouldn’t hedge at prices above $1,000 per ounce and saw no cap at even $1,300 per ounce in the current weak-dollar and commodity binge-like environment. As shares in the company rose, sellers of the April puts at the 50.0 strike helped send premiums lower from $1.85 to $1.40. With less than one week to go before expiration in the March cycle, some investors placed bets on a near-term spike in Barrick’s shares price towards the $60 marker where March calls were bought heavily for a tiny $0.10 per contract. At the March 55.0 strike put, sellers lined up to take in the declining premiums starting the day at $2.80. Since then puts have practically halved in value and traded down to $1.50 apiece.
RIO – Option implied volatility spiked by about 10% at Brazil’s super heavyweight miner, Companhia Vale do Rio Doce. Shares failed to maintain a one-week high before slipping on the day to stand at $33.79, while option activity was noteworthy given the rise in put and call premiums. Activity was well balanced with no special bias to either side of the fence. It looks as though traders wagered that near-term prices would stall and took a credit for selling the March 35.0 calls in exchange for buying the 37.50 strike for a net $0.45. Meanwhile the March 32.5 puts were sold indicating that investors feel that the share price is likely hemmed in between those two nearest strikes before options expiration next Thursday. In the April contract calls at the 35.0 strike were purchased at around $0.55 implying profits above $35.55. The April 32.5/30.0 put spread was also purchased as an investor looked for potential mild slippage in the share price.
SHPGY –American depositary receipts in U.K. drugmaker Shire held on to a 3% gain at $59.10 following early-morning reports of a bid from Pfizer. With options trading at 6 times the normal level this morning, virtually all of the early session activity lay in March and April calls. The front-month 65 call strike has attracted volume in excess of open interest, trading to the middle of the market at 55 cents. The brunt of the activity is centered in April calls, where apart from the call-buying at the 67.50 strike, the call activity at strikes 60, 62.50 and 65 appears highly liquid and with no discernible directional bias. Premiums on all of these strikes are up some 100-300% on the session. Heading into today, open interest showed almost 5 times as many call positions open as puts.
NCT – Newcastle Investment Corp – Shares in this New York-based, publicly traded REIT dropped 15% to $8.86 after the company announced a reduction in its quarterly dividend due to cash retention needs and liquidity constraints. A rush for investors to seek protection against further erosion below the $8.00 52-week low over the next week sent option volume to triple the normal level. This played out at the March 7.50, which was heavily bought at 50 cents apiece, implying another 20% drop below current levels by next Thursday.
