Microsoft Options Surge on Settlement Speculation

No settlement was announced, but that didn't stop options traders from making a lot of money.
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Microsoft

(MSFT) - Get Report

would not comment on rumors or speculation Tuesday, though plenty of both abounded on Wall Street. Investors bought stock, observers lit up message boards and news programs filed reports, all seemingly convinced that some resolution of the

Department of Justice's

antitrust lawsuit against the company was at hand.

The rumors, it turned out, were false. But the speculation was real and, potentially, quite lucrative.

Around 11:15 a.m. EST, traders on San Francisco's

Pacific Exchange

, where bids are yelled out openly, began buying call options on Microsoft stock at a price of $25 per contract. Hearing the demand, traders began calling their firms, according to Robert Koggan, an options trader at

Miller Tabak

, which does not own Microsoft stock.

The activity caused a ruckus for good reason.

Each call option represents the right to purchase 100 shares of Microsoft stock for $100 a share. The options that were being purchased are dated December, meaning they would expire on Friday. Because the stock had opened at 96 3/16, the options traders were betting that the stock price would rise more than $3 before Friday's close, or their options would expire out of the money -- a Wall Street term meaning worthless.

"Because people see out-of-the-money call buying in a stock that has potential to have news, immediately the speculation started," Koggan said. "One person sees options trading and says maybe it could be a settlement and another person says there's speculation and by the third phone call it's a settlement."

Reacting to the speculative options activity, stock traders began buying Microsoft shares at ever-higher prices. At 1 p.m., the stock exploded. It reached 101 1/8, beating the 52-week high of 100 3/4, by 2 p.m., before turning down again after the Department of Justice dispelled the rumors. Microsoft shares closed at 98 11/16, up 2 1/8 for the day.

Through it all, Wall Street chattered.

CNBC

,

Reuters

and

TheStreet.com

all reported that each other had reported that there were rumors of a settlement.

On the message boards, talk was just as fast and loose. Under subject headings like "Can you say SETTLEMENT!!!!" and "DOJ must be close by Friday," anonymous stock watchers howled theories ranging from the exultant ("Gates is KING ... Go baby GO!!!) to the conspiratorial ("they are not Y2K compliant and all records of the case will be lost").

From the actual parties involved, far less was heard. A Department of Justice spokeswoman said the rumors were unfounded, and a Microsoft spokeswoman said: "If there is any information, it would be posted on the

PressPass

Web site, so you can check there for updates."

There was nothing there.

Even sell-side analysts were skeptical that any sort of new development was in the works, much less that any concrete information was fueling the stock price's gain.

"It's the kind of thing that you know the company is not going to comment on, the Justice Department is not going to comment on," said Aaron Scott, analyst for

Advest

. He rates the stock a buy, and his firm hasn't done underwriting for Microsoft. "Even if somebody is crouched outside the courtroom, they just see people going in and out, they don't hear what's going on."

In the antitrust case, Judge Thomas Penfield Jackson has made a preliminary ruling that Microsoft has a monopoly and predatory marketing practices. Judge Richard Posner of the

7th U.S. Circuit Court of Appeals

was named to mediate the case. Many on Wall Street believe the company's stock price has been depressed by the litigation.

While no real news emerged in the case Tuesday, there was real money to be made in speculating it would, even for those who left the stock alone and stuck to options.

Between midday and the close of trading on Tuesday, roughly 22,000 Microsoft option contracts traded, as compared with a hefty 30,000 contracts already "opened" in that strike price.

The options opened at a price of 1/4 ($25 per contract) and closed at an average of 1 1/4 ($125). Thus, the buyer of one call option could have made 400% in one day buying at the start of the rumors and selling just prior to the close of trading.

"What we know is that the stock has risen to a new high based on speculation," said Koggan, the options trader.