As Witches Near, Option Volatility Rises

One day before a key expiration Friday, at least one index option trader says bears have sharpened their teeth so much that a short-term rally is bound to be on the way.

Volatility Index Today % Change 28.91 +9.59 Source: ILX

Meanwhile, Sprint (FON Quote) surfaced yet again on the speculation roulette wheel, with more talk out of the Chicago trading floor that the telecommunications giant could be weighing a buyout offer of $65 a share.

That kind of takeover talk is nearing two years of age, but, according to at least one analyst, DeutcheTelekom AG (DT Quote) is looking more and more the likely bidder.

Put/Call Ratio Today (Noon) Previous Close 0.61 0.56 Source: ILX

First, though, back to the stock market's worry grind. "We're seeing lots of investors buying collars on the indexes," said a trader on one of the institutional trading desks. "They're selling out-of-the-money calls going out to January of 2000, taking that premium and buying puts dated in October, either at the money or slightly out of the money." That position benefits from a short-term pullback because the value of the calls drops and the puts rise on a downturn over the next four weeks.

Indeed, a huge trade in the Standard & Poor's 500 index October 995 puts, about 5,700 contracts, crossed this morning. Open interest was just 315 contracts. The S&P itself was down 16.1 to 1301.8.

Greg Simmons of Linear Capital Management says any expiration week is messy to try and fight the market's cross currents and speculative hoards. Better to exit earlier than later, he adds, "kind of like avoiding an Irish pub on St. Patrick's Day. You'll get your toes stepped on and really lousy service."

Simmons doesn't have any positions this week, but given where the broader market's fear gauge is, warns: "I would cover your shorts at this point."

In other words, the VIX, the Chicago Board Options Exchange's Volatility Index, has popped to just over 29 Thursday after creeping higher all week. "When the volatility is at 28, that's my signal that if I were short the market, I'd cover and look to see it come back, with the S&P somewhere in the neighborhood of 1340."

Now, back to our regularly scheduled options activity in Sprint.

Blake Bath, a telecom analyst with Lehman Brothers, puts it this way: Deutsche Telekom, which has a 10% stake in Sprint, has "signaled that they will be an aggressive acquirer going forward. That suggests they would be highly interested in Sprint." OK, so it's analyst-speak squared, but a price tag of $65 a share from Chicago-based traders is at least new.

As with all takeover rumors, caveat emptor. But with Sprint's shares up 9/16 to 48 1/4, the out-of-the-money call buying in worth watching. Heavy call buying in Sprint was noted beginning in last week's column. The October 50 calls mentioned then are trading for 3 3/4 ($375), up from 3 ($300) last week.

"You have to understand, this deal has been talked about so much that it's too risky to play it with the stock," explained Lillian Seidman with Miller Tabak options trading firm in New York City. "That's why there's been so much pumped-up interest in the options." Call buyers risk less when they choose the option over the stock because the capital outlay in less.

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In other call-buying activity, a market maker in Navistar (NAV Quote) options dropped us a line that the October 40 and 50 strikes have been "seeing some careful and intelligent buyers" and that "Volvo (VOLVY Quote) is the name out there."