Lehman's Options Plays Suggest Fear

On the heels of the mid-June announcement of a $2.8 billion quarterly loss, Lehman Brothers (LEH) announced $6 billion in fresh financing, and conceded that an additional capital infusion would likely be required. Option traders smelled blood and starting buying chunks of put contracts. Lehman might be in deep trouble, according to their bearish bets.

To be sure, conditions could still materially weaken for Lehman. The investment bank still has $65 billion in risk exposure, which is likely to be subject to greater stress if the economy weakens further. Since the bank has not disclosed certain large illiquid positions, "investors continue to assume that there is something to hide," notes UBS' Glenn Schorr.

As the stock slipped below $23 a share, volume and implied volatility flew to record levels. The July 20 put traded over 30,000 contracts, the July 15 put traded a whopping 43,000 contracts, and the $10 put traded 15,000 contracts. The prices paid averaged $2.50, $1 and 50 cents, respectively. This represented an implied volatility of nearly 150%, which suggested the option market was pricing in a $7 (or 30%) price move within the five weeks remaining until the July 18 expiration of these options.

This option action was certainly reminiscent of what occurred in the days preceding the collapse of Bear Stearns. But while that prescient trade certainly reaped a windfall for those on the right side, the holders of Lehman put options seem to be pinning their positions more on hope than price action.