Rumors IBM May Warn Spur Put-Options Buying

Even the old reliable blue-chip companies that have consistently shown earnings growth have their turn at being put through the warning rumor mill.

Investors are expressing bearish sentiment on IBM(IBM Quote) by buying put options , as talk of the company issuing a profit warning has resurfaced. (A put option gives the holder the right, but not the obligation, to sell the underlying stock at a set price.)

Volatility Index
Today	% Change
23.83	-0.13%
Source: ILX

According to Briefing.com, many investors are skeptical that IBM can escape the economic downturn in IT spending unscathed. Some of the company's competitors, including Hewlett-Packard(HWP Quote) and Sun Microsystems(SUNW Quote), have issued profit warnings, which leads investors to believe that it will be difficult for IBM to avoid the same predicament.

Nasdaq Volatility Index
Today	% Change
56.02	+2.75%
Source: ILX 10 a.m.

The implied volatility of IBM options has ticked upward to 40% from 34% over the course of the past week. Yesterday, investors were eager to purchase near-the-money put options, or options with a strike price near the share price, on the warning rumors.

"No one is immune to the slowdown," agreed Paul Foster, options strategist and editor at 1010WallStreet.com. Foster pointed out that Tellabs(TLAB Quote) "hung tough for a while," but it grew weaker over the past few weeks, culminating with its profit warning after the close of regular trading Tuesday. As for IBM, "They need to get their act together and acquire some assets," Foster said. He added that a prime target for such an acquisition would be some of the telecom companies that have taken quite a beating recently.

On Wednesday, the July 110 puts traded roughly 3,700 contracts on open interest of 19,337, with the premium ranging from $3.80 ($380 per 100) to $4.10 ($410 per 100). The July 115 puts were the most active, trading more than 7,000 contracts on open interest of 16,499. The premium on those puts is more expensive at $6.00 ($600 per 100) because they are closer to the strike. The stock finished regular-session trading Wednesday down $1.75 at $113.09.

Today the premium on the July 115 calls shot up $1 to $7 ($700 per 100), as the share price of the underlying stock has dipped $1.27 to $111.82. With the stock dropping, investors are looking to buy the cheaper puts, the July 110 puts and even the July 105 puts. The July 110 puts have traded about 1,400 contracts this morning already. The premium on those puts is up to $4.60 ($460 per 100). Despite an expensive premium, the July 115 puts did trade about 1,300 contracts on open interest of 21,353.

Buying puts outright, at the market or below the market, is considered a sign of pessimism. But in this instance, investors were buying protective puts in an attempt to protect gains made from the stock's recent performance -- the stock is up 23% in the past three months.

Today, however, Salomon Smith Barney analyst John Jones issued a research note in which he wrote, "We expect earnings per share to meet our $1.16 estimate or miss by a penny or two. If it comes in below our outlook, we give a 50/50 chance the 2001 outlook could be guided down 10-20 cents -- no big deal in this market in our view."