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Index Option Plays Muddled on Down Day

Volatility is up but not enough to make the contrarians happy.

If the stock market party is starting to wind down, at least index options are still rocking away.

Trading was predictably heavy in the key


, or

Standard & Poor's 100

, index options Friday after financial and technology issues bled away the week's gains following on a stronger-than-expected April

consumer price index

. The figure came in well above expectations and may force the

Federal Open Market Committee

to shift toward a tightening bias at its meeting next Tuesday.

But the predicted increase in the fear factor -- an expected spike in


volatility index percentages -- isn't being priced in, according to one options veteran. And that could mean there's a little more downside in this market.

"Buying on the dip has worked for so long, people think the market is just going to rally again," said Kyle Rosen, president of hedge fund

Rosen Capital Management

and options analyst for

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"Take the S&P 100 options with a duration of one-to-three months, at 5%-10% out of the money. When this news came out, we expected the volatility to spike to around 35 or 40," Rosen said. "But it didn't. It was just another normal day with the vols in the 20s. Everyone has been lulled into a false sense of security."

The OEX was down 13.1, or 1.9%, to 676.1. As a result of the market's worries, the May 670 puts traded more than 4,400 contracts and their premium jumped 3 3/8 ($337.50) to 7 ($700).

Adding to concern about the overall market, "the index put-call ratio has been out of whack," said Jay Shartsis, director of options trading at

R.F. Lafferty

. "It's just that there's a lot of hedging in there.

The Chicago Board Options Exchange index options put-call ratio totaled 1.39, a whopping change compared with Thursday's ratio of 2.49. While the number is usually higher than the reading for individual stock options, the 1.39 number is unusually low for a weak day in the overall market. The ratio, however, had been higher the previous two days, showing that institutions were intent on hedging their portfolios.

Meantime, the equity put-call ratio has been showing a lot of call-buying in the individual names, and according to the contrarian logic of the options market, "lots of call-buying is bearish," Shartsis said.

Meanwhile, call buyers in bank stocks earlier in the week likely got their heads handed to them Friday. The

Philadelphia Bank Index

has dropped 34.24, or 3.69%, to 892.62. A report Thursday issued by

Warburg Dillon Read


J.P. Morgan

(JPM) - Get JP Morgan Chase & Co. Report


Morgan Stanley Dean Witter


attractive takeover candidates, further driving call-buying in banking and financial stock options.

Typical of the action was trading in J.P. Morgan, where Thursday takeover rumors carried June 145 calls up 4 5/8 ($462.50) to 9 ($900).

By midday today, those same 145 calls had lopped off 2 ($200) to 5 7/8 ($587.50 per contract), although trading was much lighter than the previous trading session, with only 23 contracts traded, compared with open interest of 185. The stock price had fallen 5 1/4 to 141 1/2.

"Everybody who bought is further smacking it down. Very few saw this coming. Everyone was bullish on bonds, anything interest rate-sensitive. Now the selling is feeding on itself," added hedge fund manager Rosen. "There is essentially one more day to push your short

positions before Tuesday," when the FOMC meets.

Traders came in waves for



calls today on speculation that the company could be acquired by




Pacific Exchange

traders said the implied volatility of Raychem options had risen to over 150 today from the typical 30-40 levels. The busiest of the bunch were the May 30 and 35 calls, purchases that likely were paid for by sales of the October 35 calls. The stock was up 1 5/16 to 30 3/4 this morning.

The May 30 contract's premium jumped 15/16 ($93.75) to 3 1/4 ($325) on volume of more than 860 contracts. The offsetting sale of the October 35 calls brought in 3 3/4 ($375).

This is the second time recently that Raychem options have been unusually busy, traders said. During April's expiration week with the stock at around 22, buyer of the April 25 calls paid 3/8 ($37.50) for the contract with just two days left. It closed April 16 at just over 30.

Associate Editor Dan Colarusso contributed to this story.