Investor Boosts Put Volume in Morgan Stanley

Big financial firms such as Morgan Stanley (MS) have obviously been under scrutiny throughout the economic crisis but have seen a great deal of stabilization since March. But in the past few days, the shares of some of the financials have underperformed the market, and UBS put on more pressure with caution warnings yesterday morning, according to published reports. Many of the stocks will see a rally early today, however, thanks to the positive news the Bank of America (BAC) will repay its TARP money. Yesterday, at least one investor bought some puts out in 2011 in a move that could be seen as reducing some risk exposure to MS.

The investor bought more than 30,000 January 2011 22.5 puts for roughly $2.35 per contract versus open interest of 43,000 contracts. This was the largest volume we saw across all strikes in MS yesterday. The buying action pushed the price of these options up 17 cents on the day Wednesday, and implied volatility closed at 50.

MS shares closed down 92 cents to $30.60 on Wednesday. Put buyers are looking for a 19% drop in the stock throughout the next year to enter into profitable territory, unless the stock falls and the puts rally before expiration, prompting the investor to sell out of them.

But I want to highlight that this put purchase may have been a closing transaction for the buyer, which is why I said that it might be risk reduction, rather than just a flat-out bearish bet on MS. The reason I say that this may have been closing is because we now see that open interest in this strike is 40,045. So at least some of the purchased options were bought to close.

The implied volatility of the 2011 options series was well over 75 starting in September of 2008 and lasting well into March of 2009. That was logical because of the great deal of concern about the future of financial firms in general. Longer-dated options are used, among other things, as a hedge for people who might be short credit default swaps. If the investor who was short these puts was buying to close yesterday, it shows they were taking profits, after having been short these puts and watching them decline.