Options Investors Queue Up for the QQQs After Goldman Downgrade

Following an en masse downgrade of technology stocks by investment bank Goldman Sachs this morning, investors played the Q note, trading options of the Nasdaq 100 Unit Trust(QQQ Quote), a tracking stock for the tech-laden Nasdaq Composite Index.

Goldman reduced 2001 revenue and earnings estimates for a whole slew of software companies, including seasoned heavyweight Microsoft(MSFT Quote). In addition, the firm trimmed its forecasts on Hewlett-Packard (HWP Quote) and IBM(IBM Quote).

Volatility Index
Today	% Change
23.63	+1.63%
Source: ILX

Goldman cited "continuing weakness of current business coupled with our view that the recovery, when it comes, will almost certainly not pack the punch of prior recoveries. In many instances, the stocks have already largely discounted these sorts of changes, with many tech stocks now moving back and forth within fairly definable trading ranges."

Nasdaq Volatility Index
Today	% Change
53.11	-1.67%
Source: ILX

Not only did this drive the market down this morning, but also it sparked heavy options volume as well, in both calls and puts. (A call gives the holder the right, but not the obligation, to buy the underlying security, while a put gives the holder the right, but not the obligation, to sell the underlying security.) The QQQ July 42 calls traded about 26,500 contracts on open interest of 18,765. The premium, or cost of the options, ranges between $2.45 ($245) and $2.60 ($260). On the put side, the July 40 puts traded over 26,000 contracts on open interest of 78,204, with a premium of $1.05 ($105). After an early decline, QQQ shares traded up 32 cents to $43.68 in afternoon trading.

Investors "are selling the volatilities thinking the stock is going to sit," said Paul Foster, options strategist and editor at 1010WallStreet.com. Foster believes that this is a case of an institutional investor, most likely a hedge fund, taking its losses and hoping for the premium to erode further. He also added that it is difficult to nail down the exact strategy because it's impossible to know what other positions the investor is holding. But the bottom line is that these sellers of volatility would like the underlying stock to stay between $40 and $42.50.

Elsewhere, Honeywell International(HON Quote) and General Electric(GE Quote) continue to be on the tip of everyone's tongue as arbitragers remain intrigued with the floundering merger. With Honeywell's share price moving lower out of the gate this morning, the arbs began selling the July 35 calls, according to one trader at the Chicago Board Options Exchange. (Arbs bet on takeover plays generally buying the stock of the target company and selling short the stock of the acquiring company.)

The July 35 calls traded 11,000 contracts on open interest of 23,168. Selling calls outright is considered a pessimistic trade. However one trader said that once the stock began to firm up, the arbs bought the out-of-the-money calls because there was no new negative news out on the merger. The July 40 calls traded about 11,500 contracts on open interest of 39,760 as investors paid $1.70 ($170) for the premium. The July 45 calls were even more active as about 25,000 contracts changed hands on open interest of 18,365. The premium on those calls was pretty cheap at 35 cents ($35) this morning, but has ticked upward to 75 cents ($75) in recent trading. Honeywell shares traded up $1.19 to $36.79 in recent trading.

Analysts have all but buried this deal given the European Commission's strong antitrust concerns, but the EC still has until July 12 to reach a final decision.