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Option Activity Flags Bets on Some Homebuilders

What is the options market seeing in homebuilders? Certainly a lot of sector risk, but also some opportunities, according to Rebecca Darst of Interactive Brokers.

"I think it's interesting to take a look at the activity in Ryland yesterday," Darst said in an interview on CNBC's "Squawk Box." "This is a stock that, the options in Ryland have been very bearish since last November, but what we saw yesterday was the highest level of call volume in Ryland since October 31, 2007." (See Darst's full comments, plus observations from Jim Cramer, in the video).

"Calls" are options that give investors the right to buy a certain stock at a specific price in the future. Investors buy them in the hopes that a stock will climb in price beyond the call's "strike" price, thereby producing a profit when the option is exercised.

What to make of call activity?

"First of all, we imagine that the bears are going to be very nervous about getting squeezed on the short positions," Darst explained. "Secondly, we're going to expect that the bulls may be looking for strategic opportunities within the sector, maybe trying to pick out those companies that are going to be best-positioned to take advantage of opportunities when they present themselves again. ... Then, thirdly, we might look for clues in implied volatility or in call positioning for any evidence that there might be consolidation in the industry, looking for possible takeover targets."

Ryland "is an interesting company," said Darst. "They've tended to focus on, I believe, first-time home-buyers. They've got a lot of exposure in the Southeastern part of the United States. They've got a lot of exposure in Texas, where subprime defaults have been a big problem. Their CEO, earlier this year, was very tacit, if not judicious, about making any sorts of forecasts about what you can expect from the housing market in 2008."

Darst said call interest is also very pronounced in the XHB , which is the homebuilders' ETF.

"We've noticed a lot of caller activity in the June contract in the XHB. This has been going on for a number of weeks now. I don't know if June has just been pointed out as some sort of inflection point for the housing market."

She said Lennar has also seen activity.

"I want to be very careful how I phrase this, but a lot of the day yesterday, I understand that options in Lennar were trading as if the stock might be a potential takeover target. There's not any specific rumor that I can point to. Keep an eye on implied volatility, because one hint is, when you see implied volatility in the further-month option contracts trading relatively muted, and yet, a strong, very pumped implied volaitility, front-month, upside calls, that can be an indication that a stock is being looked at by option traders as a potential takeover target."

On the whole, she indicated the homebuilding sector still faces a lot of risk, with many traders taking "short" positions ... essentially bets that stock prices will fall.

"The homebuilders remain a very volatile bunch of stocks, and that short interest is high in a number of tickers in this sector. I mean, if you look at Beazer Homes , if you look at Hovnanian , if you look at Standard Pacific , there is an elevated level of short interest," she warned.

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