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As Fen-Phen Worries Fade, American Home Call Buyers Look Phat

The recent options play in American Home Products (AHP - Get Report) may have some investors wondering if there's anyone out there down on the stock these days.

Volatility Index
Close Today % Change
21.33 +2.40
Source: ILX

The trading in American Home's options has been a highlight in the market lately, with the price of its options and call -option buying in the stock being noted by several options market analysts.

Put/Call Ratio
Close Today Previous Close
0.50 0.42
Source: ILX

While there's been some takeover chatter surrounding American Home, there is another likely reason for the pickup in its options volume and options price: On Thursday, a hearing is slated regarding the fen-phen diet drug litigation against the company.

In May, American Home reached a settlement with class-action claimants who alleged they were hurt by two diet drugs that were withdrawn in 1997 after reports of heart valve problems.

In a report earlier this week, Merrill Lynch said the hearings Thursday will deal with the timing of settlement payments. Merrill said "any rearrangement of payment schedule will have little impact on the overall settlement" and that the judge in the case will approve the settlement "some time following" Thursday's hearings.

Following an approval of the settlement, Merrill said it expects American Home will move quickly to reach a settlement with the law firms representing those who have opted out of the big settlement.

Last year, American Home took a charge of $4.75 billion to provide for expected claims. The company, however, said last month that the $4.75 billion amount wouldn't cover total fen-phen liability.

Regardless of why traders are diving into American Home options, the direction they're betting on the stock taking is clear. Open interest and trading in options lately indicate that they're obviously looking for American Home to rally.

Since the close on July 21 to Wednesday's intraday price of 56 7/8, American Home's stock has risen 8%. Wednesday, the shares were slumping 1 1/4 to 56 7/8.

The enthusiasm can be seen in the amount of open interest -- the number of contracts existing for a particular option -- on American Home's call options. Open interest in the in-the-money August 55 and 60 calls stood at nearly 9500 and 14,000 contracts, respectively. September and October 60 call options posted open interest of 5649 and 5044, respectively.

Put -option open interest, however, is negligible compared to the call open interest overall in American Home options.

Larry McMillan, of McMillan Analysis, highlighted in a note to clients Wednesday the action in American Home's options Tuesday, pointing out that 13,113 contracts traded Tuesday, 11,675 of which were calls, compared to overall average volume of 6274.

In a commentary, McMillan wrote that American Home options were showing that rumors that made the firm "a takeover possibility last week" were "gaining strength again" although actual stock volume was "not confirming" it.

The analyst also noted that the implied volatility -- the annualized measure of how much the market thinks a stock or index can potentially move and a critical factor in an option's price -- on American Home's options was "very high" lending "credence to the rumor."

Over the past three years, mergers planned with SmithKline Beecham (SBH), Monsanto (MTC) and Warner-Lambert have all fallen apart for American Home.

While the vast majority of the action in American Home options appears bullish, contrarian traders may want to take the opposite side of the American Home bet. The options universe is populated by many contrarians who believe strong action in one direction is a sign that a cycle is ending and that the stock will soon behave in the opposite manner. To them, the heavy call buying means American Home could be in for a selloff.

The big Cisco (CSCO - Get Report) September 60 put option purchase last week isn't looking so smart in the wake of the networking giant's earnings report after the close Tuesday and the continued advance in the company's stock.

The stock's going to have to crumble badly for the options to go into the money. Cisco was up 2 3/8 to 67 7/8.

The September 60 puts were trading down 1 9/16 ($156.25) to 1 3/16 ($118.75) on the American Stock Exchange Wednesday morning.

The trade could still work out for the put buyer if Cisco runs into weakness between now and Sept. 15, when the options expire. Or, if investors bought the puts as protection against a long position in the stock, puts might still come in handy. Nevertheless, something severe is going to have to happen for the trade to look good.

The International Securities Exchange, the first all-electronic options exchange in the U.S., said it traded its one-millionth contract Tuesday.

The ISE, which launched May 26, currently lists 70 equity options, with the aim of eventually trading the top 600 equity options. The ISE said six of 10 primary market makers and 25 of 100 competitive market makers have been activated, with the remaining markets makers scheduled to become operational during the exchange's continuing rollout phase.

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