Election Delay Keeps Drug Stock Options Pricey

Continuing their pre-election surge, options prices on drug stocks continued to be expensive Wednesday, but some options pros said there's more to those high levels than expectations that George W. Bush will be the next president.

Volatility Index
Close Today	% Change
28.28	+5.48
Source: ILX

Drug stocks have rallied lately on bets that GOP presidential candidate Bush will win the election. But as Wednesday unfolded with the election too close to declare a winner, some options traders said the flight to drug stocks and the corresponding rise in their options prices was in part a defensive play to offset stumbling Nasdaq stocks.

Put/Call Ratio
Close Today	Previous Close
0.65	0.53
Source: ILX

Among drug company stocks, Merck (MRK Quote) gained $4.38 to $91.25; Glaxo Wellcome (GLX Quote) added $2.81 to $59.88; Pfizer (PFE Quote) rose 94 cents to $45.75; and Eli Lilly (LLY Quote) advanced $3.94 to $91.19.

On Monday, with some investors confident of a Bush victory, players took out bullish positions in drug stocks, which rallied that day. By Tuesday, however, some traders said pros were putting "collars" on long drug stock positions to hedge themselves, suggesting they weren't exactly comfortable that Bush would pull out a victory.

Generally when an investor owns a particular stock, a collar involves buying an out-of-the-money put and selling an out-of-the-money call against the long stock position. The purchase of the put is financed by the sale of the out-of-the-money call.

Buying an out-of-the-money put provides the right to sell the shares at a price somewhere below the current market value, while selling an out-of-the-money call essentially provides the same opportunity at a price higher than the current market value if your stock position gains in value. So, if a slide in the stock is dramatic, the puts provide an escape hatch. If the stock runs up, selling the calls provided the investor some extra income in addition to a clear exit point if those calls are exercised.

Some investors have been nervous about a victory by Vice President Al Gore, the Democratic party candidate, because of his campaign-trail rhetoric against drug companies. Bush proposals, on the other hand, have maintained pricing structures less onerous to the Big Pharma companies.

What's kept drug-stock options prices high is the portion of those prices built by uncertainty, a factor called implied volatility, or "vols," to trading floor inhabitants.

"Drug vols are through the roof," one Wall Street options trader said.

Volume on drug stock options, however, wasn't earth-shattering, some analysts noted. About 1,200 of the November 45 calls on Pfizer traded at the American Stock Exchange, up 1/4 ($25) to 1 3/4 ($175).

Elsewhere, Merck December 95 calls were trading up 1 1/16 ($106.25) to 2 9/16 ($256.25) on light volume overall.

Meanwhile, the Chicago Board Options Exchange Volatility Index, a measure of anxiety in the market, rose modestly. Generally the VIX rises when put buying on options on the S&P 100, or OEX, increases.

Overall, investors buy puts to use either as insurance against a long stock position or to speculate on a downswing in the underlying stock or index. Conversely, investors buy call options hoping for a surge in the underlying stock or index.

Uncertainty over the outcome of the election was taking some of the blame for the selloff, noted one options trader. The trader said "you don't want not to know" who the president is going to be for three days, noting that the results wouldn't be immediately known.

The Nasdaq Composite Index slumped 2.4%, while the Nasdaq 100 dropped 3%.

Michael Schwartz, chief options strategist at CIBC World Markets, said going forward, he's expecting to see a lot of unwinding of defensive pre-election put option purchases by investors. What those investors will probably do is cut their losses on puts and let long positions run, he said.

"We'll probably close the year with a nice rally," Schwartz said.

Traders said Microsoft (MSFT Quote), another stock investors had played in anticipation of a Bush victory, wasn't getting much play in the options market Wednesday.

For the past few weeks, the stock has soared. On Oct. 17, it closed at $50.44 and Wednesday it was trading at $70.50, a gain of about 40%.

Conventional wisdom says that Microsoft will be a winner if Bush wins because a Bush administration is seen as more friendly to the software giant regarding the antitrust action.

The aforementioned options trader said that while there wasn't much telling action in Microsoft options, he did note that an institutional investor over the past two days has shorted a total of roughly 8 million shares of Microsoft stock. Microsoft was unchanged to $70.13.

Options-wise on Microsoft, the November 70 calls were being heavily traded, particularly on the CBOE and the Pacific Exchange. On the CBOE, nearly 4,500 contracts traded, up 1/16 ($6.25) to 2 5/8 ($262.50).