Portfolio Protection Still at Large

Even as crude slipped to an 18-month low, stocks are struggling to hold in positive territory. The S&P 500 chart is turning even more bearish, as the lower line of the uptrend channel has been pierced and is fraying; a close below 1400 would make it safe to say the market has rolled over.

The put/call ratio did tick up to 0.76 yesterday and has opened at 0.78 this morning, but as I mentioned last week, these readings remain relatively low, and overall volume, especially in index-related put options, is lackluster, suggesting there is a reluctance to allocate capital to portfolio protection, let alone make outright bearish bets. This, of course, could have negative connotations as it becomes more difficult to buy dips if working without a safety net.

Sprint (S - commentary - Cramer's Take) is leading the most active list as its shares tumble some 10% after a sales warning. The most active strike is the January $17.50 put which has traded over 18,000 contracts at 20 cents as people look for short-term protection. But it looks like some investors might be using this as a buying opportunity, buying longer-dated calls to gain upside; the most active call is the May $19 strike which has traded over 12,000 contracts at around 80 cents.

AtheroGenics (AGIX - commentary - Cramer's Take) provides another example of how trading biotechs is so treacherous. Some would just call it gambling, especially when the company's prospects are FDA or test-result dependent. On Monday, shares of AGIX soared 30% to $13 as investors expected Phase 3 results for its coronary drug to be released as early as this week.

After the close the company said is doesn't plan to release the initial results until late in the first quarter, causing the stock to sink back 10% to $11 per share. But the shift in date is also wreaking havoc on the implied volatility across the option chain, specifically, a huge crush in IV in the January options, while the IV in the February and April options is flying. The IV in January has dropped from 250% to around 95%, the IV in February has moved up to 220% from about 150%, and the IV in April options has soared to 240% from around 90% on Monday.

One of the takeaways is that when playing a biotech with a pending drug result -- but without a firm release date -- it always makes sense to buy longer-dated options to ensure the option will not expire before the news is released. It can be very costly to pay huge premiums in anticipation of price-moving news only to have the date pushed back beyond your expiration date.

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Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback; click here to send him an email.

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