Options activity in lumber liquidators

Bulls sitting long of stock in Lumber Liquidators must feel like they were whacked in the head Monday with a two-by-four. The double-digit-dollar decline in the value of its shares has wiped more than 20% off the value of the company in the wake of Sunday’s "60 Minutes" documentary alleging the U.S. retailer of hardwood flooring had installed Chinese-made laminate flooring containing formaldehyde at unacceptably high levels.

The chemical has been known to cause cancer. Option activity on LL is concentrated in the front March contract, which has attracted about three-quarters of the overall 31,000-contract volume. With the stock sliding to below $41.00, the lowest strike attracting bearish activity is the $35.0 strike put where volume of 8,600 lots dwarves open interest of about 1,000 lots.

However, the May contract attracted more bearish plays where volume is rising above 700-lots at the 25.0 strike. Why is there a lack of action in the name beyond the March expiration? Well, perhaps investors are expecting a swift conclusion to the allegation, ahead of which implied volatility has surged to 100% (+48% on the day).

The effect of elevated fear on options premiums is evident when you look at straddle prices at the 40.0 strike over time. The combined cost of call and put expiring in March of $7.40 implies the range for the share price at expiration of $32.60 to $47.40. For the April contract the implied range spans $29.40 to $50.60. And for the May contract the range is even wider, from $27.40 to $52.60. The defensive nature of option traders driving up implied volatility when crisis strikes is apparently sufficient to deter further downside speculation at this point.

Chart shows serious allegations at Lumber Liquidators caused options implied volatility to surge.