Options Get Expensive; Insurers Fret, 99-Cent Soars

It's not a good time for the options market, according to one observer.

"Option premiums are very high," said Rebecca Darst, an options analyst with TheStreet.com, on CNBC Friday. "It's a frustrating time to be trading in the options, because it's...I would say the premiums are prohibiltively high for anyone who enters an options position on the long side. Which is why you see, even for people who are entering directional positions, you're going to see them using spreads and maybe limiting the amount of risk that they take on, limiting the amount of profit that they could hope to realize as well. However even when you see a substantial move in the stock to the up or the down side, the premiums are so pumped up that you may not be able to close out the option position at a significant profit.

Insurers are in for especially rocky times, Darst suggested.

"The implied volatility will tell you it is toil and trouble for the insurers across the board," said Rebecca Darst, an options columnist with TheStreet.com. "There's a lot of concern as to whether insurance companies might seek some sort of federal assistance, under TARP funds, for example; we're in the midst of a very rocky earnings season for a lot of insurers. What's interesting from an implied volatility standpoint is that in many of these names you're seeing spikes in implied volatility, even after the numbers are already out. After Hartford Insurance lost half its value yesterday, we saw a dramatic spike in its implied volatility. It closed the day 75 percent higher; we saw action in the front-month puts at strikes as low as the $7.50 strike."

And the pressure is likely to remain, she indicated. (See her full interview in the video)

"The metaphor that people often use in describing the options market is that options are like insurance policies for stock prices, and when the options market feels like there's an increased risk to a certain stock, then the premium is going to go higher on that, and here we're seeing increased risk premiums being ascribed to insurance companies. We saw very negative numbers in a number of insurers yesterday, very high implied volatility readings; however, there's one in particular that I'd be keeping an eye on just in terms of the options activity, and that's Endurance Specialty. The share price actually closed 4 percent higher yesterday, but the implied volatility on its options spiked 86 percent yesterday. That was higher even than the spike we saw in Hartford, and with a higher close yesterday, we saw a 3,000-lot bearish put spread entered in the November contract. This was at strikes 25 and 20, with the trader buying the 25 strike, selling the 20 strike put in a bearish play. This was done for a debit of about $1.60, so what you're going to see in terms of the break-even is requiring about 19 percent off yesterday's closing levels. They've got three weeks to make that move, because the expiration is November 21, so it's a relatively short period of time to make a substantial move in the implied volatility readings that we're seeing on all these insurers tell us that options traders feel that there's at least a potential move of that magnitude."

But there is one bright spot, Darst pointed out.

"The 99-Cent Only Store , this is an absolutely charming story, because as every other stock in creation has been getting hit, this guy set a 52-week high yesterday. Three months ago, they were trading at six dollars; now, they're trading up above 12, so that's pretty good. The reason why it caught our attention yesterday was because its options were trading at four times the normal level. Bear in mind, this is not an options series that trades very actively, so even 1500 lots is going to set off some alarm bells. But what we saw were traders actually buying January 12.50 calls in the 99-Cent Store. They were actually paying more than 99 cents for these contracts. They were paying $1.50. Bear in mind that because option premiums are very high, if you want to break even on your trade, you're going to have to see a pretty substantial percentage type move in the stock, and so traders may be looking futher afield to something like January positioning in the at-the-money strike there, because they feel that it's more realistic to get that kind of a gain in that sort of time frame."