Friday January 18, 2008
WaMu earnings add to buyout speculation…implied volatility remains high
Today’s tickers: WM, ADLR, MBI, UA, XLV, AMD, CREE
WM – Shares in Washington Mutual are showing an unusual 5.5% gain on the day to $13.12, despite reporting a nearly $2 billion loss for the fourth quarter of the year that included a $1.6 billion after-tax write-down on its home loan exposure and a credit downgrade from Standard & Poor’s. Options in Washington Mutual are among the most actively traded on our platform this morning, with implied volatility at 129% remaining sharply elevated above the 100% historic reading. A look at the volume shows brisk traffic in January calls at strikes of 12.50, 15 and 17.50, carrying over into the same strikes in the February contract. Speculation on further consolidation in the beaten-down financial space gathered speed earlier this week when JPMorgan chief Jamie Dimon reported that he was “open” to possible acquisitions, with Washington Mutual tipped in the media as a potential target. Today’s earnings report may have served to bolster speculation that the company will be unable to carry on without the intercession of a buyer.
ADLR - Shares in Adolor Corp. are trading 14% higher at $4.57 ahead of the noon hour, after an FDA review of its drug Entereg, a remedy co-developed with GlaxoSmithKline for the treatment of post-surgical constipation, was inconclusive in finding links to heart attacks and abnormal cell growth. FDA officials will convene next Wednesday to discuss the review’s findings. In the meantime, Adolor options are trading at eight times the average volume as its implied volatility bounded 27.7% higher to 251%. This compares to the 91% degree of turbulence that Adolor shares have documented historically. Given the high implied volatility reading and its inflationary effect on call-side premiums today, it appears that some traders took the opportunity to play against sustained gains for Adolor shares by selling April 5.0 calls for $1.00 apiece.
MBI – Shares in the country’s largest municipal bond insurer MBIA declined 21% to $7.26, setting a new 52-week-low, on this morning’s news that credit default swaps are currently pricing in a more than 70% likelihood that it and fellow bond insurer Ambac will go bankrupt. Prices on credit-default swaps rise as confidence in a company’s solvency declines. So too does implied volatility on a company’s options, and MBI implied volatility rose steeply by 16.6% to read 327.7% earlier this morning. The volatility reading reflects even more ingrained fears over MBIA’s counterparty risk than has already been made evident in the 200% degree of fluctuation its shares have already shown. With more than 35,000 contracts trading ahead of the noon hour, MBIA options are among the day’s most liquid, with heavy activity in calls and puts at the January 7.50. Because this traffic exceeds the level of open interest, we can see that this is fresh volume as traders wage speculative bets ahead of today’s expiry. February puts traded at strikes as low as 2.50.
UA – Selling pressure continues to mount in shares of sportswear maker Under Armour. Shares are down nearly 19% to $30.00, a new 52-week low, following an analyst downgrade of the company. Yesterday we observed a similarly steep sell off, with attendant rise in trading volume, on concerns in the market that Under Armour may have socked too much money into an ambitious Super Bowl TV ad campaign. Once again, its options are trading at 4.6 times the normal level according to our “Hot by Options Volume” scanner, with the equivalent of 1 out of 4 of its open option positions actively traded. We gather there are least some contrarian bets on a Super Bowl upset for Under Armour shares, given the volume we observed in February 35 calls, which traded to the middle of the market for $1.55 – a 73% discount from yesterday’s level. Prior to today, Under Armour’s 52-week low was $34.80, so a buyer of this strike would take advantage of lower call-side premiums today to play on a rebound back to that previous low before February’s expiration.
XLV – It’s been a dicey week for health care stocks, what with doubts over the efficacy of a Merck/Schering-Plough cholesterol drug, and an article in the New England Journal of Medicine scrutinizing the effectiveness of prescription antidepressants. Shares in the XLV, the Health Care Select Sector SPDR, are trading 1.5% lower as a result. Components in this exchange-traded fun include Pfizer, Merck, Pfizer, Eli Lilly and Bristol-Myers Squibb. Our market scanners detected an increase in option trading volume to more than 9 times the normal level, as the equivalent of more than a quarter of its open interest was traded. This was heavily localized in February puts, where puts at the 35 strike were bought for $0.70 against the sale of puts at the 36 strike at $1.10 for a transaction credit of $0.40. Open interest at both these strike levels accumulated from virtually nothing to 10,000-plus contracts this week alone, suggesting that today’s volume may represent a trader taking some of a prior position off the table.
AMD – Shares in number-two PC chipmaker Advanced Micro Devices are basking in a near-10% recovery to $6.96 today – this as its arch-rival Intel headed yet lower, loitering at the $19 level this morning. A lower-than-expected Q4 loss in AMD’s after-the-bell earnings report yesterday corroborated early signs that the company’s badly-distressed share price may have turned a corner. The report added to insult to Intel’s recent injury with AMD stating that Q4 demand remained strong and consistent with seasonal patterns (Intel’s report earlier this week suggested lagging economic growth could dent demand). With 54,000 options trading this morning, AMD is one of the day’s most actively traded option families, and a look at volume and volatility suggests option traders don’t think the company is out of the woods quite yet. Implied volatility came down 25% after the earnings report, but at 82% it’s still sharply elevated above the 68% historic reading and suggests traders pricing in about 20% more share price turbulence from AMD than it has already shown. Holders of the January 9.0 put may have looked to close out their positions by buying back positions for $2.07. February traffic occurred in calls at strikes of 6.0, 7.0 and 8.0, with the delta on that latter strike suggesting a barely 30% chance of AMD shares closing above $8.00 in February. The chance of a close about $7.00 are currently better than 50/50.
CREE – Unusual activity was observed in another component of the semiconductor space – Cree, the maker of light-emitting diode chips used in digital camera flashes and cellular phones. Cree shares are down nearly 4% to $25.30 ahead of its earnings report next Tuesday. Having delivered downside surprises the past two quarters, tension is building in anticipation of the report, as borne out in the 13% increase in implied volatility, which now exceeding 100% is the highest reading we have on record for Cree options. Positioning today appears to show traders looking for more downside into the month of March, with calls at the March 30 strike selling for $1.35 against the purchase of puts at the same March strike for $7.00. The high premium on this strike would require Cree shares to decline another 10% from current levels by March just to break even. Selling the call at the March 30 strike defrays the initial cost outlay somewhat, and is also an indication that the trader doesn’t expect a return to $30 levels that would result in the call being exercised.
Andrew Wilkinson and Rebecca Engmann Darst
ibanalyst@interactivebrokers.com
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