Net Plays Abound Before Earnings Reports

Amazon and AOL report this week, and options traders are getting ready.
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Earnings, earnings and more earnings remain the focus of options traders this week, especially in money-losing Internet companies, where "results" typically substitute for "earnings."

Investors are casting an eye this week at Internet giants

Amazon.com

(AMZN) - Get Report

and

America Online

(AOL)

and their options this week. Both companies are set to release financials Wednesday.

With the options expensive in the days before earnings reports, playing expectations often proves dicey. But if the raw data tell the Street anything, Internet stock options may actually start behaving like "normal" options, in that the implied volatilities rise -- but don't explode off the charts -- around earnings. Part of the reason for that normality may be the regular dysfunction of the options that causes their volatilities to be consistently high.

"Stocks like this always have a run-up in implied volatility because of earnings, and with Internet companies, it's even more insane," said one Philadelphia-based options trader. A year ago, when Internet stocks frequently doubled, tripled or quadrupled in price, Internet options traders would price that into the options accordingly. "In one or two days, it wasn't uncommon to watch volatility run up from 80 to 150," he said.

Still, Amazon.com, for example, has a history of trading in a range and then tripling for no reason. "Based on its history, if that happens again, you would rather own calls on a higher strike than a lower one for the money you shell out," he explained.

Or, he added, this could be a perfect opportunity for some sort of combination position to use the higher prices to defray the cost of earnings speculation.

For instance, with Amazon.com shares trading at around 131 Monday, "you could sell the at-the-money 130 calls and puts and buy the 145 calls and 115 puts. If the stock stays where it is, no big deal -- but if the company disappoints, you make money."

Amazon.com August 130 calls were selling for 13 3/4 ($1,375), down 4 1/8 ($412.50), the puts at 10 1/2 ($1,050), up 1 5/8 ($162.50); August 145 calls were trading at 6 7/8 ($687.50), down 3 5/8 ($362.50) and the August 115 puts at 4 5/8 ($462.50), up 3/4 ($75).

Heavy trading in name-brand financials was highlighted by action in

Morgan Stanley Dean Witter

(MWD)

calls, which leapt off the screen Monday morning.

The investment bank's August 105 calls gained 5/8 ($62.50) to 4 ($400) per contract as volume climbed to more than 5,000 contracts against open interest of just 733. Morgan Stanley shares rose 1 3/8 to 101 5/16.