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The

purchase of

Phelps-Dodge

( PD) by

Freeport-McMoRan

(FCX) - Get Report

for $26 billion, or a 33% premium, is sure to fire up options activity across the mining sector.

While the implied volatility on the options for the two merging companies will likely decline sharply, names like

Inco

and

Falconbridge

will surely see renewed speculation, and call-buying will push IV levels higher on the day.

I also expect this deal to torque up takeover talk in the steel industry. That lit up last week on word that

U.S. Steel

(X) - Get Report

was a target of a Russian company. This is likely to spill over into other names like

Chaparral

(CHAP) - Get Report

,

Olympic Steel

(ZEUS) - Get Report

and

Nucor

(NUE) - Get Report

, whose shares and IV will get a lift as the industry looks to consolidate.

Something about the American steel industry is similar to the ongoing pattern in the airline industry -- namely, a bunch of companies either go into or narrowly avoid bankruptcy, slim down and become more efficient operations. When they finally regain some pricing power and are on somewhat firm footing, they look to make costly acquisitions.

Granted, airlines have a host of issues that steel does not, and steel and mining probably do reap some benefits simply through scale of operation. However, growth through acquisition should always be looked at with a wary eye.

On another note, I know that the grinding-higher market action has offered little real volatility. Yet, I find it amazing that implied volatility -- especially in index measures like the VIX and across most of the technology and retail sectors -- remains near multiyear lows, even as we enter what is traditionally one of the busiest times of the year. Maybe everyone is just pricing in this week's Thanksgiving and expecting slow holiday trading to begin early in December.

Looking at the Calendar

For my part, I might start looking at buying calendar spreads -- that is, selling December options and buying longer-dated ones, such as those with March expiration. This would be a net debit position (you do pay out money), but the accelerated decay of the December options sold short should mitigate the impact of theta or time erosion on the value of the position.

The position would also benefit from an increase in IV, which should occur as the calendar turns to 2007. Depending on which strikes you pick and whether you use puts or calls, long calendars are good low-cost, limited-risk way to establish directional bets.

The main drawback would be a sudden increase or decline in price, which would push the position deep into or way out of the money. This is doubly negative if it's the result of a merger, which causes IV to decline dramatically.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Olympic Steel to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback;

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