Options Percolate On Takeover Chatter

A number of takeover rumors have been making the rounds, an encouraging sign that capitalistic optimism is returning to the markets.

Our hedge fund network estimates that M&A rumors were up some 80 percent in the last week alone. This is clear evidence for traders that those who had left the market are pouring back in.

Here is a sampling of stocks that saw unusual buying fueled by takeover speculation last week:

--Black & Decker : A rumor that Danaher could buy drove shares from $26.35 to $32.41

--MEMC Electronic Materials : A rumor that BASF could buy drove shares from $15.26 to $19.26.

--Allergan : A rumor that either Baxter or GlaxoSmithKline could buy drove shares from $39.53 to $50.89.

On Friday, someone tried to start a takeover rumor that retailer Lowes might be interested in Whirlpool . We looked at the option volumes and noted that, just two minutes before the rumor surfaced, someone bought 408 of the April 35 calls for $1.50. The stock spiked from $33.19 to $35.88 in just minutes, but then we noted the unusual selling of calls, which to us signaled a classic "pump and dump" move.

Here are some key questions that can help evaluate such actions:

--Is volatility expanding? Look to see if the options are becoming more expensive without being driven higher by shares of the underlying rising.

--Are more calls being bought on the offer than sold on the bid? When we see equal volumes sold on the bid as bought on the offer, then we do not have unusual activity.

--Is the subject of the takeover rumors relatively cheap compared with its peers and or recent valuation? Or has it already moved up and thus a less likely acquisition target?





Jon 'DRJ' Najarian is a professional investor, CNBC contributor, and cofounder of OptionMonster.com.