Expiration Watch Keen on Dell Options

If you've ever gone sailing in a hurricane, it's about as easy as trading on expiration day.

Options Buzz: Join the discussion onTSC Message Boards. "Expiration always juices up the volume as option investors buy and sell stock like maniacs, but the rest of the world thinks it's a rigged game -- and to some extent, it is," confided the head of one institutional options trading desk.

Volatility Index Today % Change 26.11 +4.15 Source: ILX

Think of it this way: You're a retail rowboat trying to steady on in an institutional Mississippi. Big firms on this morning are buying back and selling hundreds of thousands of options, and each trade is usually paired with mammoth blocks of stock. "Most people just stay out of the marketplace," the trader said.

Put/Call Ratio Today (Noon) Previous Close 0.45 0.46 Source: ILX

Still, there are always those special expiration-day plays. This time around many are watching Dell(DELL Quote), because there is a massive open interest in the February 40 call options.

The swirly activity is due to an expiration-day phenomenon known as pinning the strike, when traders with large positions can keep the options they sold from landing in the money simply by selling shares of the stock. With Dell at 40 1/8, down 9/16 at midday, it could get hairy.

This month's expiration also seems to be confirming a trend where fewer investors are using index options such as the S&P 100 contract, called the OEX, to hedge their portfolios.

Index options, many of which won't expire until next month, aren't seeing the activity they once did. "More of the business is in the tech names -- Applied Materials(AMAT Quote) and Cisco(CSCO Quote) -- and aside from that we keep seeing the divergence of the Dow and the Nasdaq. While I can't say there's no index hedging going on," said Kevin Murphy, retail option strategist with Salomon Smith Barney, "we do see a lot more stock specific hedging."

Murphy says when investors are long the market, they "just always hedge that now with OEX options. You have to be do more stock specific hedging."

Even hedging the Nasdaq 100 unit trust, the mighty QQQ(QQQ Quote), can be enough to rock your boat. "You can have one individual name -- a Qualcomm(QCOM Quote), for instance -- that can go against you and really smack the index down." Nasdaq lists the weightings of the QQQ on its Web site.

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There was some interesting activity to watch: A huge buyer stepped in to buy 4000 Home Depot (HD Quote) out-of-the-money March 50 puts. With Home Depot shares up 7/8 to 55 3/8, the March 50 put is currently fetching 1 ($100), down 1/16 ($6.25).

The buyer is speculating that Home Depot's shares will fall to 49 by the third Friday in March or slide close enough to 50 to push higher the value of the March 50 puts, which give the buyer the right to sell Home Depot shares at that price by expiration.

On the more bullish side, some options traders were jumping on the biotech bandwagon by playing one of the industry's biggest firms, Amgen(AMGN Quote).

Friday volume brought a 3000-contract trade in the out-of-the-money March 80 calls, which were up 7/8 ($87.50) to 3 3/8 ($337.50) as the stock reached 75. The open interest in that strike price totaled just 1380 contracts.

The calls give the buyer the right to buy Amgen shares for 80 by the third Friday in March. It would be a profitable endeavor if the stock landed at about 84 on that day or rose enough to carry the price of the option higher.

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Meanwhile, the market's fear gauge, the Chicago Board Options Exchange Volatility Index, or VIX, has been creeping higher. The VIX closed Wednesday at 25.10, at the top of its typical range of 17.0 to 25.0, but well below the 45-to-50 levels touched in 1998.

"According to our research, the VIX appears to be understating market worries a bit," says Lance Ettus with ValueLine Options in New York City. Friday, the VIX hit an intraday high of 26.35 before settling back to 25.86, up 3.15%.

Further evidence that options are expensive: Ettus also points out that the average three-month put-and-call time premiums of all the options ValueLine follows are at their highest levels since the 1987 crash -- even higher than they were during the financial crisis of 1998. (Premium is the cost of an option).

"The reason for this discrepancy between the VIX and these average premium levels is the divergent market we are seeing these days," he continues. His argument goes like this: The low correlation of very volatile stocks within an index tends to dampen the volatility of the total index. So, the OEX, S&P 500 index, or SPX, and the Nasdaq may not have been that volatile recently, while individual stocks have. "Another reason for these high premium levels may be that investors have become very defensive buying equity puts, as they lost confidence in 1998 in the effectiveness of indexes as hedges," he adds.