Today’s tickers: MER, CCU, ATI, MAR, ELX, MOS, CEPH
MER– Yesterday’s comments from CEO John Thain about Merrill Lynch’s capital adequacy coincided with what we termed a “self-congratulatory” mood for bank and brokerage stocks as Senate lawmakers listened to a play-by-play rundown of last month’s Fed-underwritten sale of Bear Stearns. Today, the market’s sway has turned from the self-congratulatory to the self-critical, with calls from a former UBS-insider urging the Swiss bank to consider a breakup, and a Financial Times interview with former Citigroup exec John Reed lamenting the various M&A moves that created that banking behemoth. It’s from that perspective that we consider the option action in Merrill Lynch, whose shares are trading 1.7% higher at $46.69. With more than 89,000 option contracts in play, it’s conspicuous to us that 3 times as many puts trading as calls, suggesting a high degree of “second-guessing” the current direction of the share price. For clues on the mood ahead of Merrill earnings, we look to the May contract, where it appears that the sale of out-of-the-money puts at the May 37.50 for $2.14 would have represented a funding vehicle for the purchase of puts at the 45 strike for $4.32. The resulting long put spread, initiated with a debit of $2.18, presupposes a decline for Merrill Lynch shares below the $42.82 level, but remaining above the 52-week low of $37.25.
CCU– A date has been set for the New York City courtroom showdown between two private equity companies and a Citigroup-led consortium of banks over the mutinied funding of the LBO of radio operator Clear Channel. While Clear Channel shares advanced 1% to $28.65 on news that the case was on the court docket for May 5, option traders took the opportunity to accumulate defensive positions in the May contract. Calls at the May 32.50 strike sold for $2.00 apiece on volume of more than 23,000 lots – well exceeding open interest, and possibly indicative of a trader looking to take premium to fund costlier defensive plays in the puts. Similar sentiment was in evidence in what looked like a 10,000-lot spread between strikes 25 and 32.50 in the May contract. The trader in this case would likely have bought the higher-strike puts for $5.77, locking in the right to sell Clear Channel shares for $32.50 by May expiration, but would have sought to limit trade costs by selling the 25 puts at $1.40. The resulting $4.37 debit would have created a break even for the trade at $28.13 and resulting profits for the trader if Clear Channel shares continued their decline to $25. The common denominator of all these trades is an expectation that Clear Channel shares will not exceed $32.50 heading into what may be a very messy, convoluted and acrimonious courtroom drama.
ATI– Elsewhere, the early session volume in the option market was heavily swayed by what one might call the “rumor elves” of M&A activity. Those who follow the market will undoubtedly be aware that these creatures are wont to come out of the woodwork on Fridays. Call volume in Allegheny Technologies, the maker of specialty and alloy metals for the aerospace and chemical industries, hit its highest level since July 2007 today on apparent rumors of a takeover of the company. The move came just after a key analyst downgrade of the stock. With options moving at more than 8 times the normal level, traders clearly are game to the rumors surrounding this stock – so much so that they’ve put the equivalent of every fourth Allegheny option contract in play. Fresh buyers are flocking to out-of-the-money calls in the April contract at strikes of 85 and 90 – the former contract trading at 6 times the open interest. Implied volatility in Allegheny options has moved very marginally on the news, with the 57% reading indicating just a 4% added price risk to the underlying share over the coming month.
MAR– Shares of hotel giant Marriott are up a meager 1.3% to $36.47, but its option activity bears all the hallmarks of takeover talk, which has visited the stock before. A 15% spike in implied volatility to 45.6% coincided with a near-12-fold spike in option volume, most of it tied up in fresh out-of-the-money call buying at the April 37.50 and 40 strikes. While Marriott shares are up a respectable 3.8% for the year so far, it last traded at the $40 level last November.
ELX– Emulex Corp. – A familiar name to those who follow the annals of infamous stock market bear raids (Emulex was the target of a notorious securities fraud scandal 8 years involving untrue rumors that impacted its share price negatively). Today, shares of the California-based maker of storage networking infrastructure solutions for Intel-based server clusters dived 8% to $15.43 on no apparent news catalyst, in step with a near-22% spike in implied volatility and a 25-fold increase in option trading volume. Puts are outmoving calls by 5 to 1, with heavy activity at the April 15 and 17.50 strike lines. A predominance of long interest on either side of the May 17.50 line suggests possible straddle activity occurring in that month.
MOS– A near-10% advance in shares of fertilizer giant Mosaic followed a bullish Q3 earnings report. With shares at $114.48, we see twice as many calls as puts represented in the active moving volume of 41,000 lots, with brisk two-way traffic in April 110 and 115 calls as the value of these contracts has advanced 80%. Heavy buying interest in the front-month 120 and 125 calls suggests that Mosaic’s momentum – which has been due in large measure to rising crop-nutrient prices in a climate of very high commodity prices – could catapult the company past its 52-week high of $119.78 even before the April contract is through. Mosaic has traded as low as $27.25 over the past 52 weeks.
CEPH– Defensive sentiment is also building ahead of a May 6 FDA advisory panel hearing on the safety of Cephalon’s narcotic painkiller Fentora, which it hopes to see approved for prescription against flare-ups of severe, so-called “breakthrough” pain in non-cancer patients. Cephalon’s Fentora is one of two notorious painkillers to come under the scorch of the FDA searchlight – Purdue Pharma’s OxyContin is also under review for its reported addictiveness. Fentora was implicated in the deaths of four people during its first year on the market as an opiate painkiller for cancer patients. Uncertainty over the outcome of the hearing, which will come 5 days after Cephalon’s earnings announcement, is apparent from the implied volatility reading, which at 37% is dramatically elevated above the 30.4% level of volatility recorded in the underlying share. With Cephalon shares up 2% to $66.04 over the noon hour, option traders do not appear heartened by today’s share price action and are positioning very defensively in the April and May contracts. Puts at the April 65 strike traded for $1.25. Meanwhile, fresh long positions were entered in May puts at strikes as low as 20 cents for the 50-strike.
