Options Report: Financials May Face Another Big Selloff

Activity in the options market may be signaling another major selloff in financial shares.

Implied volatility, a component of how options are priced, rises in anticipation of greater swings in the actual shares tied to a put or a call.  For names caught up in the recent market turmoil implied volatility has skyrocketed.

"It's continued anxiety in the near term over instability in the financial stocks," says Paul Foster, option strategist at web information site theflyonthewall.com.  "We won't be getting the clear answer on the financials until earnings in September. People are not used to the recent price movements and spreads in the stocks" which is stoking fear."

One of the most glaring examples is Countrywide Financial. The mortgage company, which today said foreclosures and delinquencies among home loans it services rose in July to their highest in at least several years, has seen implied volatility in September options surge to 130. That's more than two-times above average Countrywide options volatility during the last six months.

Call options give investors the right but not the obligation to buy stock at a specified price within a certain period of time, while put options give investors the right to sell a stock at a preset level within a certain period of time.

The at-the-money Countrywide

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[CFC  Loading...      ()   ] August 25 straddle, priced at over $3, indicates investor fear that the stock could see a move of more than 10 percent.

An options investor uses a straddle, which is the simultaneous purchase of a call option and a put option with the same strike price, when there is uncertainty over the direction of the underlying stock.

Implied volatility in options has also surged to two-times or more beyond the six month average in names including Lehman Brothers, Goldman Sachs and Bear Stearns.

Beyond individual names, the gloom investors are feeling toward the overall financials group remains deeply entrenched.

In the XLF – Financial Select Sector SPDR

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[XLF  Loading...      ()   ], 11 put options have traded for each call, according to Andrew Wilkinson, senior market analyst at Interactive Brokers.

"Call trading was an afterthought today," says Wilkinson. "Major volume occurred in the put series at the January 31 and 34 strikes where volume registered 31,000 contracts in each option."