Cramer on How Options Are Hounding Philip Morris

By James Cramer

Options expiration is up to its old tricks again.

Take Philip Morris. One day after the tobacco talks look hopelessly stalled, we learned of a crucial breakthrough that could make it a reality any minute.

The market likes these negotiations because -- no matter how ugly and costly it gets -- a deal takes infinity off the table. Without such limits, some funds will never ever own Philip Morris. Too many other fine companies have been destroyed by the plaintiffs' mass tort bar to take a chance that Morris won't one day fall prey to these vultures.

A deal means that Morris won't end like A.H. Robbins or Eagle-Picher.

So why didn't Morris go up Wednesday?

That's easy: The open interest in the June 35 calls is just way too great. There are 38,000 contracts, the equivalent of 3.8 million shares, laying on top of Morris, and all of them can be considered for sale.

Let's review the options process. People speculating there could be a settlement for the tobacco companies want to play the upside without incurring too much downside if the talks break down.

The perfect instrument for some time to play the upside is the June 45 call. For the last few days you have been able to buy this contract for anywhere between 75 cents and a dollar, which, of course, gives you the right to any price appreciation above 45 plus the cost of the call.

But the call expires on Friday. From the looks of things if there is no agreement, Morris won't be able to lift past 45 because if you fear a talks breakdown, you can't afford to own the common stock. Without a deal there will be nothing to suddenly propel the stock further north.

So the 38,000 contracts act as a lid to further price appreciation as speculators sell these calls, or offer common stock short against them to unwind their positions.

This practice, known in the biz as "pinning the strike," goes on every option expiration. You will see stocks gravitate toward the striking prices (usually 5s and 0s) as we get closer and closer to the bell Friday. Morris is an outsized version of this pinning-the-strike phenomenon because of the talks.

What is the practical effect of this? If you think that Morris is being held down unnaturally by all of this option pressure, you might want to either buy common or buy a July 40 call. But if there is a complete breakdown in the talks, that might be too risky.

More important, it is just good to keep in mind that many stocks get similarly trapped and can be excellent investment opportunities if you keep your eyes out for stocks that suddenly, late afternoon Friday, seem to be forced down almost solely because of late Friday strike pinning.

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Random musings: Editors of the business world, can we please have a restricted list of people who are no longer interesting or powerful and are therefore not worthy of the ink you bestow upon them. The list might include:

John Malone. This joker has kept his stock mired in the teens through his own financial shenanigans for much of this decade.

Carl Icahn. This once-noted raider ceased to be a force of anything other than unconstructive comment and hasn't done anything interesting in years.

Donald Trump. Maybe he's good for tabloid headlines, but he pales in importance in the financial firmament to the fifth most important guy at Microsoft, whoever that is.

Mike Ovitz. His power seems to stem more from sycophantic reporters than from the dealmakers on Wall or Main Street.

I contrast these faded moguls with Ted Turner, Rupert Murdoch and Mike Price, all of whom are still capable of generating F-5 cyclones in their spare time. Or for that matter, Steve Ross, who, albeit dead, is more interesting than Malone, Icahn, Trump and Ovitz on their good days.

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