Yahoo! Put Options Get Busy Ahead of Earnings

Updated from 2:20 p.m. EDT

Shares of Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) continued to get hammered Monday and options action on the Internet portal was robust ahead of the company's earnings, slated for Tuesday after the bell.

Volatility Index Close % Change 22.88 +4.86 Source: ILX

Yahoo! shares were lately off 5 7/16 to 111 1/16. That weakness brought options traders heavily into its July 120 puts, where 3,128 contracts traded on the American Stock Exchange. The contract's price rose 3 3/8 ($337.50) to 12 1/2 ($1,250).

Put/Call Ratio Today¿s Close Previous Close 0.40 0.37 Source: ILX

Elsewhere in the options market, implied volatility in options on Northwest Airlines (NWAC Quote - Cramer on NWAC - Stock Picks) has perked up again due in part to renewed speculation that the airline will be bought, with AMR (AMR Quote - Cramer on AMR - Stock Picks), parent of American Airlines, mentioned as the potential acquirer.

Implied volatility is the annualized measure of how much a market maker thinks a stock or index can potentially move and is a critical factor in an option's price. When market makers raise implied volatility, they are expecting bigger movement in the underlying securities' price, in either direction. Implied volatility typically rises on takeover chatter.

On Monday, the July 40 options had an implied volatility of 85, while the July 35s were at 83, compared to a little more than a month ago when volatility was at 53 to 54, said Paul Foster of 1010WallStreet.com in Chicago.

Trading on Northwest options Monday was scant.

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The Chicago Board Options Exchange's payment-for-order-flow program, under which a 40-cent fee on designated primary market makers and market makers in all equity option classes will be charged, will be assessed retroactively to July 1.

The CBOE plan came in response to a loss of market share in certain options to other exchanges where market makers or specialists at those exchanges pay for order flow.

Under payment for order flow, as the practice is known, market makers and specialists pay brokerages for sending them orders. Critics of the practice argue that it provides incentives against finding the best price for execution.

The CBOE also announced to members Thursday the Best Execution Assurance Program, or BestEx, in part to help assure customers that payment for order flow isn't interfering with best execution. Under BestEx, each firm will receive a report in the morning showing at what price their orders were executed on the previous trading day and what the best national best bid/offer was at the time of trade execution.

Regarding the amount of money that is paid for orders, that decision will remain a matter for DPMs and the brokerage firms to negotiate. Under the CBOE plan, the market makers will tell the CBOE to pay a certain brokerage firm a certain amount of money per month for orders executed at the exchange. The CBOE will then pay the brokerage firm for those orders from the money collected from the market makers.

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The CBOE is launching another competitive missile at its rivals by adding a shrunken version of its Nasdaq 100 index options to its arsenal.

A smaller version of the CBOE's options contract on the Nasdaq 100 is expected to begin trading this week. The new contract will be 1/10 the size of the current NDX options contract, according to the exchange.

Currently, if an investor wanted to buy a July 4000 NDX call option, and the contract was trading at 145, he would have to pay $14,500 (145 x 100) to buy the call.

For the new miniaturized NDX options, the strike price on the contract would be 400, or 1/10 the size of the regular NDX options contract. If the contract on the mini-contract was trading at 14 1/2, an investor would pay $1,450 for the call.

The new contract on the CBOE will offer investors a product to trade that is closer in size to the wildly popular option contract on the Nasdaq 100 unit trust (QQQ Quote - Cramer on QQQ - Stock Picks), but not as small. Options on the regular NDX at the CBOE are almost entirely traded by institutional investors because of the size of the contract.

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The Options Industry Council said that equity options volume in June totaled 50.9 million contracts, a 60% jump from the year-ago total of 31.9 million contracts.

For the first six months of the year, volume totaled 329.6 million equity option contracts, up 68% from the year-ago 196.3 million contracts.