Thursday Options Update: FRE, LEH, NLY, XLF, GE, EWH, XLP, SGR

July 10, 2008

Freddie Mac (FRE) – In some sense, it seems nothing short of a small miracle to see major indices trading modestly in positive territory, given scuttle out of the financial space that on another day might spark an across-the-board panic (indeed, we feel compelled to note here that the CBOE Volatility Index, which tends to trade inversely with the S&P 500, is also trading slightly higher and remains above a reading of 25). First out of the gate were remarks from St. Louis Federal Reserve President William Poole, who dropped explicit hints of a government-sponsored bailout of mortgage financiers Fannie Mae (FNM) and Freddie Mac. Shares in Fannie and Freddie predictably plummeted, with Freddie Mac shares now down 21% at $8.10, and implied volatility coming in about 24.5% higher at more than 218%. Front month option activity showed selling pressure at the July 10 line in both puts and calls, which could indicate traders selling volatility at these elevated levels – a treacherous strategy in the current news environment – and seemingly offset by two-way traffic in July 7.50 puts at the 5.00 and 7.50 strikes. Put spreaders appear to be out in force in the August contract between strikes 5 and 10.

Lehman Brotheres (LEH) – The market also received a no-bones reminder of the extreme flammability (not to mention staying power) of negative rumors in the brokerage space. Rumors that Pimco might suspend its trading activities with Lehman Brothers finally sent implied volatility in Lehman options rocketing near March 17 levels, up as much as 61% earlier this morning. The panic was quelled somewhat after a Pimco spokesman issued a statement that the firm was continuing to trade with Lehman, but implied volatility is still more than 25% higher at 150%, as Lehman shares dip 8.5% to set a new 52-week low of $18.09. With more than twice as many puts as calls, we’ve seen prodigious two-way traffic in July puts at the 20 strike and below, as the value of these positions doubled and redoubled during the panic. Fresh positioning extended into the August contract, most glaringly at the $10 strike, which traded on volume 4 times the open interest at around $1.00 per contract (up more than 138% from yesterday’s levels).

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