Today’s tickers: BUD, TAP, FRE, FNM, VIX, LEH, WB, AIG, XLF
BUD– There’s no denying that many a market professional will turn to beerier, cheerier pleasures to polish off the memory of a very volatile trading week…shares in Anheuser-Busch gained 9% to $66.80 Friday afternoon on news that it and would-be buyer InBev are in amicable last-stretch talks for a takeover bid that has reportedly valued Anheuser-Busch at $70 per share. This is a $5 premium to InBev’s original $65 offer, which closely held Anheuser-Busch rejected as too low. The impact of the news has been a shrink-back in implied volatility, down nearly 25% to 19.6%. Heaviest option action has occurred in the July 65 calls, which are trading more often to sellers than buyers as the price hits $1.90 – an 1800% increase from yesterday’s levels, and probably a very tempting inducement to traders who bought into these positions in mid-June when they were trading at 45 cents apiece. We’re also seeing heavy volume in front-month puts at strikes 55, 60 and 65 (the latter strike trading at 5 times the open interest), in what could indicate traders playing the volatility. Traders appear to be steering clear of the $70 line in calls, confident that this is the absolute highest that InBev will bid.
TAP– Shares in rival Molson-Coors Brewing also rose today, up 2% to $54.25. Implied volatility at 40% weighs in more than 30% above the historic reading on Molson-Coors stock – a six-month high – which strikes us as unusual, given that its earnings announcement isn’t due out until August 5. Elevated implied volatility tends to puff up the price of option contracts – especially those rich in time value – and in that environment, many traders resort to spreads – sacrificing a little reward in exchange for more palatable trade-costs and a more realistic break-even. So it was with a 1,900-lot out-of-the-money call spread in the October contract between strikes 60 and 65. We have no confirmation of the directionality of this trade, but let it suffice to say that the $2.10 price of the lower-strike, if bought alone, would require a 14% rise from current share price levels to break even. Selling a strike higher cuts this outlay almost in half. Granted, a trader could play the other side of the bet and sell the call spread, taking in $2.10 in premium in the expectation that Molson-Coors shares will not break past their $59.38 52-week high by mid-October. In this case, the purchase of the upper strike would insure the trader against an unexpected upside move and hedge the short call position completely. Today’s October call spread sent overall volume in Molson Coors to 11.5 times the normal level.
FRE– Disastrous losses throughout much of the session for Fannie Mae and Freddie Mac accompanied speculation of a forced government bailout of the mortgage financers. Remarks from U.S. Treasury Secretary Henry Paulson (who indicated today that the Feds’ current mission was to support the financers as they are presently structured) – seemed to rule out an imminent government takeover, but did little to temper the panic surrounding the shares. Only a report that Fed Chairman Ben Bernanke had reportedly offered to open the discount window to Fannie and Freddie appeared to stanch the hemorrhaging this afternoon, bringing Fannie Mae shares back above the $10 line, though it still resulted in a 21.5% lower close on the day to $10.35. The equivalent of nearly half Fannie Mae’s open interest was in play today, as implied volatility closed 78% higher on the session to 324.4%, and comparing this shoulder-to-shoulder with the 123% degree of volatility shown by Fannie Mae shares historically tells us that the option market is pricing in about 163% more potential price risk to its shares over the next 30 days. In other words, the cost of insuring against price swings is rising appreciably as speculation over the future of the mortgage financers broadens. Puts at the July 5 strike traded at more than 10 times the open interest, attracting buyers as well as sellers as the 45-cent premium on this contract reflects about an 11% probability of Fannie Mae shares halving in value again by next Friday.
VIX– Talk of Bernanke opening the discount window to the GSE’s trimmed back the severity of the earlier session’s test of 30, and the Volatility Index closed with a 7.4% gain to 27.49. Earlier today we noted that traders were rushing to buy calls at the July 27.50 strike, where the $1.90 premium implied a move to at least 29.40 between now and next Tuesday, and the fact that these did not seem to sell off in the wake of the Bernanke report suggests that traders are sitting tight on these now at-the-money calls heading into a fresh trading week. While the clear bias was to buyers at the 27.50 strike, calls at strikes 30 and 32.50 attracted buyers and sellers, and we wondered if selling pressure in August calls at strikes 27.50 and 30 may be evidence of traders cashing out of those positions to fund the purchase of front-month protection. The cost of protecting S&P-exposed portfolios against volatile price movement over the next 3 days is up more than 100% at most strikes in the July contract. In this environment, it would be no surprise to see traders resort to VIX call and calendar spreads, selling higher-strike positions to keep trade costs under control.
LEH– Brokerage names traded broadly lower on concern that a toppling of the mortgage financers would put a definitive kibosh on securitization; this despite observations from Sanford Bernstein analyst Brad Hintz that brokerage shares had already discounted an effective halt in securitization activities. But the bearish band plays on in Lehman rumor. Barron’s reported a Thursday regulatory filing that Lehman has some $21 billion in “mortgage and other asset-backed securities on its books,” the company doesn’t originate mortgages – sharply delimiting its exposure to a Fannie-Freddie crash as opposed to the regional or super-regional banks. Furthermore, yesterday’s assurances from Pimco and SAC Capital Advisors that they had no plans to revise their trading exposures to Lehman Brothers appears to have had no sedative effect on the barrage of malignant momentum surrounding Lehman, which is proving as hard to contain as a California wildfire. Implied volatility – the risk barometer used in the pricing of options – bounded 34% higher to 237%, having earlier today crashed above the March 17, 2008 reading when the prevailing fear was that Lehman would actually suffer a Bear Stearns-like collapse. What’s certain is that option traders feel the risk to Lehman shares is especially acute over the next week, and we can extrapolate the implied volatility reading to the price of the front-month, at-the-money straddle ($15.00), which at $5.00 this morning suggests that option traders see the potential for at least a $5 up-or-down move (one-third of Lehman’s value as of this morning) from now to next Friday. Twice as many puts are trading as calls, with fresh volume at strikes of 15 and below, attracting bumper traffic from buyers as well as sellers as the value of these positions has more than doubled overnight. Lehman shares closed 17% lower at $14.31.
Elsewhere, a cursory scan of the names in our top-50 list of top implied volatility gainers offers some indication of the companies option traders feel are most in the line of fire from a Fannie-Freddie failure.
WB– Wachovia shares have long been fingered by option traders as particularly vulnerable in light of its mortgage exposures, exacerbated by a disastrous takeover of California mortgage lender Golden West Financial. So it follows that a collapse of the country’s primary source for mortgage financing would raise Wachovia’s regional problems exponentially. We saw the redoubled risk outlook reflected immediately in a 46.5% increase to 158.8% today, dwarfing the already elevated 88.6% reading on the stock. Here as elsewhere in the financial space, there is a strong gravitation toward defensive put positions, which are already outranking calls by a factor of 2.3 in terms of volume. Front-month action shows these puts mainly being bought at strikes of 10 and 12.50 – the same strikes attracting buyers in the August contract. Shares closed 10.7% lower at $11.65.
AIG – Today’s move lower in AIG comes in swift succession to an 8% loss on concerns of a rating cut at its mortgage insurance unit, and real uncertainty about the company’s new management apparatus. Today its option implied volatility rose by another one-third today to read 119.7%, some two and half times the historic reading on AIG stock, as shares slid 3.5% to $23.16, distancing AIG even further from that freshly hatched 52-week low. It remains to be seen whether we’ll experience another six-figure put volume day in AIG options, but for now it looks like July 20 puts are trading heavily and on an implied volatility reading far higher than the reading for all AIG options (implying greater demand for protection at this strike). Interest has extended into the $20 strike in August and November as well.
SLM– Options in SLM Corp., A.K.A. student loan servicer Sallie Mae, traded at triple the normal level today as shares valiant fought back from early losses to close 2% higher at $16.05. The fact that twice as many puts traded today as calls suggests that for much of the session, traders were seeking protection for erosion below its 52-week low of $14.70. In the front-month, July 15 strike puts have traded 9,000 times – amounting to more than half the open interest at that strike – at 95 cents per contract. Around midday we saw a 10,000-lot position bought on the offer at the July 10 strike, apparently reflecting a trader who expects Sallie Mae shares to surrender another one-third of their value between now and next Friday.
MER– Merrill Lynch’s implied volatility rose 22.5% to 109.5% earlier today as put volume eclipsed calls by 3-to-1 amid a 3.4% decline to $27.73 for Merrill Lynch shares. We attributed this move to poor securitization prospects for brokerages on back of a larger failure in Fannie Mae and Freddie Mae – the Securities Broker/Dealer Index (XBD) has seen a 15% spike in implied volatility on that fear alone today. Most of the front-month action occurred today in puts at strikes 25 and 27.50, trading to buyers and sellers on sharply higher premiums. In general, Merrill Lynch puts at strikes 30 and below are seeing two-way traffic as the price of the 27.50 straddle suggests as much as a $4.79 up-or-down move priced into the options between now and next Friday. That’s more than 17% of Merrill Lynch’s current share price – a huge move.
XLF– Shares in the Financial Select Sector SPDR, meanwhile, closed 2.7% lower at $18.69 on back of the Fannie/Freddie brouhaha. Earlier today we noted a heavy degree of buying pressure in July 20 calls, which traded in excess of 50,000 lots, and wondered whether it might be protective hedge positions by traders shorting the financials even at current levels. At 29 cents apiece the $20 call seems an extraordinary bargain, and indeed it’s been stripped of more than a third of its premium value since yesterday. The buying here may also be indicative of traders positioning long of volatility via strangles with puts at lower strikes. A look at the price of the 18/20 XLF strangle indicates that traders can buy this position for a combined premium of 88 cents and obtain protection in the event of a break above $20.88 or a probe of even lower lows below 17.12. That $1.35 move below current price levels is less than the decline we’ve seen in the XLF since Tuesday.
