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Merrill downside puts still active…and takeover chatter drives calls in CSC, Titanium Metal

Today’s tickers: MER, C, CSC, TIE, PWAV, GPS, ALXN, ELNK

MER, - News of Merrill Lynch’s plan to shore up its balance sheet by shedding $30 billion in mortgage-backed assets and issuing new stock sent implied volatility down nearly 25%. Shares are off their session lows but still read 1.4% lower at $24.00 as we see little indication of traders backing away from put positions that convey the right to sell Merrill Lynch shares. Heavy buying interest has been observed in August puts at strikes 17.50 and 22.50, while call volume at the August 25 level has shown two-way traffic between buyers and sellers. The same has been true of the action one month ahead at the September 25 call line, where fresh volume here is going to buyers and sellers.

C, - While speculation is rising that Merrill’s move could set the stage for a ripe new round of writedowns in the sector, Citigroup sharesare up nearly 2% to $17.77 as we show about 175,000 options trading equally to puts and calls. Heavy interest is seen at the August 15 put strike, along with what may be put spreads in the September contract between strikes 15 and 17.50. A 10,000-lot straddle appears to have traded in the January 2010 contract at the 20 strike, involving a combined premium of $9.30, which it looks like the trader sold in order to avail him- or herself of the time decay effect to erode the value of the position and allow it to be closed out profitably. Realizing the near-term volatile risk of any short option position in the financials, it appears that this trader bypassed the January ’09 contract completely and opted for the relative obscurity of the year 2010 to put this trade on.

PWAV, - Powerwave Technologies Inc – Shares are 1.5% higher at $4.17 at present dispatch, as an increase in options trading volume to 3.5 times the normal level appears in the January 5.0 calls, which were bought today at 55 cents apiece. The buyer here appears to be positioning for a break to levels not seen in Powerwave Technologies since November 2007 – meanwhile, implied volatility at 84.4% represents a sizable elevation above the 67.6% historic reading on the stock ahead of its Thursday earnings report (the implied vol reading has come down from a 10% spike early in the session to rest at the current 84.4% level.

GPS, - Shares in everyman clothier Gap Inc rose 2.4% to $16.53 this morning as we registered an increase in options trading volume to 5 times the normal level well in advance of the Gap’s August 21 earnings report. Today’s volume was fresh and heavy as a pair of durable chinos at the August 17.50 call line, which sold to the bid heavily at 25 cents per contract in what may represent traders taking premium on a bet that Gap shares won’t break $17.50 by August 15 (despite having tested that level last week). Implied vol at 45.6% shows a slight increase above the 44.4% historic reading on the stock.

TIE- There’s been no shortage of takeover-driven stocks early in the session either, as evidenced by the action in Titanium Metals Corp. Implied volatility is up nearly 12% at 88% – its highest reading in at least 52 weeks and a full 22 percentage points above the historic reading on Titanium Metals Corp stock more than a week in advance of its earnings report. With calls outmoving puts by more than 10 to 1 today (and trading on their heaviest volume in more than a month), most of the action is based in August 12.50 calls (Titanium Metals Corp shares are up 6.3% to $11.32 at present), which are trading at 55 cents apiece and on sharply elevated implied volatility (102.5% at this strike alone), implying strong buyer demand at this strike. We should mention that Titanium has been the target of many and varied takeover rumors before –recent rumor speculation tipping Boeing and Chalco as possible buyers.

CSC- Formless takeover chatter appears to be driving the action in CSC this morning, with shares up 1.7% to $46.69 and a boost in options trading volume to 6 times the normal level (the highest level of call activity in more than a month) as call-buyers flock to the August 50 and 52.50 strikes in seeming anticipation of an upside move of 6-12% for the stock (not including option premiums). Implied volatility ticks in at 42.6% at present, which is little change from levels recorded over the past two weeks but shows a mighty elevation over the 29.4% historic reading on the stock. Comparing those figures together should convey that option traders are pricing in an additional 44% price risk to CSC shares compared to what they’ve exhibited historically. CSC is due to report earnings on August 5.

ALXN- Shares in biotech Alexion Pharmaceuticals, which develops drug therapies based on blocking so-called “complements” rose 8.5% to $86.74 after surprising the market with Q2 profits of 6 cents per share (street consensus had favored a loss heading into the report). What caught our interest is that implied volatility in Alexion options – while it’s come off by more than a third since the numbers were out – remains at 43.7% highly elevated against the 33.9% historic reading on the shares. This is an indication that the options market was taken aback like the rest of the market with Alexion’s earnings surprise and is still undecided with the current price of the stock – which means there’s still a risk premium being added to options prices even with the numbers already out. Earlier today we noticed options trading at twice the average level, with most of the action at the suddenly-in-the-money August 80 call strike. It wouldn’t be surprising to see a trader take profit on this call position, given that it increased in value nearly 72% overnight to $8.50. Since then we’ve seen traders take to put spreads between strikes 65 and 75.

ELNK- Shares in Earthlink rose 11.4% to read $9.69 as of the noon hour after the company surprised the market with net income of 48 cents where street consensus had predicted about 36 cents per share. As was the case with Alexion, Earthlink’s implied volatility at 44.3% remains elevated above the 38.2% historic reading on the stock – in fact, it’s barely budged since the earnings report was out. This means that the options market is tacking on a higher premium to lock in share prices over the next month as the market grapples with the right going price for its shares. An increase in options trading volume to 6.6 times the normal level bypassing the front month and buying into upside at the more-cost effective September 10 strike, which traded for 55 cents to more than 2,600 buyers today.

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