Option activity Tuesday has been focused on earnings and a possible cancellation of a much anticipated merger.

The CBOE Market Volatility Index (VIX), which is based on the implied volatility of the S&P 500 options and is used as a gauge for fear in the market, was recently up 1.64% to 14.91. The CBOE Nasdaq Volatility Index (VXN), which measures the implied volatility of the Nasdaq 100, was recently up 0.43% to 16.29.

Options of health care stock Guidant ( GDT) were extremely active as traders speculated that its merger with Johnson & Johnson ( JNJ) might not go through. Shares of Guidant plummeted more than 10% after J&J's Chief Financial Officer Robert Darretta said the company would consider "alternatives under the merger agreement" during its postearnings conference call. In reaction, speculators began selling calls and buying puts in Guidant options.

The October 70 calls have traded 39,300 times; the open interest for the strike coming into today was 176,835 contracts. The sellers of these calls are not anticipating the merger to take place. They could have sold the calls to collect income as the stock slid or could have used the proceeds of the sale to purchase puts. Guidant would need a significant move up by Friday's expiration in order for these calls to be considered in the money.

The October 75 calls have traded 8,000 times. The October 65 puts have traded 34,000 times. The buyer of puts is expecting GDT stock to trade below $65 a share by Friday. The November 70 and 75 calls have traded a total of 30,000 contracts while the November 65 puts have traded 13,000 times. A bulk of the trading has taken place in the October and November options. The outer-month options have been less active because of the longer-term uncertainty with the merger. It looks like traders are not anticipating the merger to go through by November expiration, which is Nov. 18. Shares of Guidant were recently lower by $7.63, or 10.5%, to $64.75.

J&J, meanwhile, saw the October 65 calls trade 6,100 times after the company's earnings beat estimates by a penny. Even though the stock is trading higher, someone most likely sold the calls. The reason for this is that the calls are out of the money and were already priced in anticipation of an upward move in the stock. So with a solid earnings release, traders likely believe the stock already has had its move to the upside. And with expiration in three days, the calls most likely will expire worthless. The stock was recently up 92 cents, or 1.5%, to $63.92.

Yahoo! ( YHOO) continues to see bullish option activity ahead of its earnings report later today. Traders are concentrating their buying on the 35 strike in different months. With the stock trading just below the $35, traders are anticipating a strong release, which would push the stock above the 35 strike. If traders bet on the wrong side and the stock trades lower, the October 35 calls most likely would expire worthless on Friday. So far, the October 35 calls have traded 29,600 times; the November 35 calls have traded 18,700 times; and the January 2006 35 calls have traded 11,000 times. The stock was recently up 52 cents, or 1.5%, to $34.68.

A day after Altria ( MO) received a favorable court ruling in a tobacco case, the stock traded lower ahead of its earnings release Wednesday and Friday's expiration. Both events can put pressure on a stock. Stocks tend to gravitate toward the strike, with the highest amount of open interest for that month's expiration. Currently, the October 75 calls have an open interest of 120,350 contracts. With this, many traders would expect Altria's stock to close at or around $75 a share on Friday. If the stock closed where it is currently trading, it would need a 1.5% move to the upside for the calls to be considered in the money.

So far today, the October 75 calls have traded 23,700 times; the November 75 calls have traded 16,000 times; the December 75 calls have traded 12,500 times; and the January 2006 80 calls have traded 19,000 times. The October 70 puts have traded 20,000 times. The buyer of these puts most likely wants to protect a position to the downside in case of an earnings disappointment tomorrow. The stock was recently down $1.04, or 1.4%, to $73.92.