Options Report: Brokerage Stocks, Macy's, Expiration Bias

Options speculators chasing after rumors that Lehman Brothers would be forced to announce exposure problems to subprime derivatives paid little attention to the firm even after it called the rumors "unfounded".

"The rumors regarding subprime exposure are totally unfounded," said a Lehman spokeswoman.

The Lehman statement failed to quell bearish options speculation, or take the underlying stock meaningfully above the worst levels of the session. Lehman put option volume overwhelmed call volume by a margin of 3 to 1.

Punk Ziegel's earlier downgrade of brokerage names including Lehman served as a catalyst for the bearish speculation.

"There a lot of anxiety about who's involved with subprime exposure," said Paul Foster, options strategist for theflyonthewall.com. "Lehman doesn't have the worldwide, money center cache like Citigroup and JP Morgan."

Foster said "the very emotional traders" have been piling into the July put options which will expire on Friday. Over 19,000 Lehman July 70 puts traded by just after noon New York time, versus open interest of more than 38,000 contracts.

Whether speculators have erred in buying out-of-the-money puts so close to expiration remains to be seen, but Foster noted that "as always there are two sides to the trade" including those who have sold the puts who stand to make money if the stock fails to fall below the 70 strike price.

The bearish Lehman options speculation spans well beyond the July contracts. More than 8,000 August 70 puts have also traded, along with more than 1,000 August 65 puts. In the most far out bet, more than 7,000 Lehman January 40 puts also traded on the offer at just after noon, a hedge on the possibility that Lehman shares would fall precipitously over the next six months.

Foster says not only is options volume and implied volatility elevated in Lehman, but also in options of Merrill Lynch, MBIA, Goldman Sachs, Morgan Stanley and Bear Stearns.

Expiration

There has generally been an upward bias to the market going into options expirations, according to Todd Salamone, senior vice president of Research at Schaeffer's Investment Research, but not in every expiration week.

Expiration of stock options happens on the third Friday of each month.

Salamone says 13 of the last 18 expirations have featured a move higher for the market, explaining that a buildup in puts at the start of an expiration cycle a month before has tended to cap market rallies early in the cycle.

Explains Salamone, "our theory is that a buildup of puts related to hedging, caps the market as market makers short futures to hedge positions in the puts that have been sold." Salamone says that as expiration nears and puts lose value those same market makers can ease up on their short futures positions "which creates upward bias" in the market going into expiration.

The upward bias on expiration weeks isn't always a guarantee, especially when circumstances arise such as renewed subprime fears and some weaker than expected earnings. This week, adds Salamone, the expiration statistic may go from being 13 of 18 to 13 of 19 upward expirations absent a quick rebound in the market in the next few days.

Macy's

Not everyone sees a buyout of Macy's as a sure thing. Earlier Women's Wear Daily reported that Kohlberg Kravis Roberts and Goldman Sachs were close to reaching an agreement to buy the department store operator at $52 a share or about $24 billion. The Dow Jones newswire, citing sources, has since reported that Goldman is not involved in a bid for Macy's . Both Bank of America and Credit Suisse also issued research reports downplaying the possibility of a Macy's LBO. Macy's shares have been trading about $2 below the best levels of the session.

The Women's Wear Daily report, which also cited sources it didn't name, said the parties were trying to iron out out a deal by Monday.

Options traders have jumped in head first with the strongest volume in the August contracts where call volume is swamping put volume by a margin of about 6 to 1.

At the very least, the news from Women's Wear Daily is salvation to holders of Macy's July calls from the 42.5 strike and up. The Macy's July 42.5 call is up $1.50 today to $1.50.