Xerox (XRX) and Abbott Laboratories (ABT) Options Activity

Xerox (XRX) and Abbott Laboratories (ABT) Options Activity

Steve Claussen’s midday market update, plus options trading in Xerox (XRX) and Abbott Labs (ABT)

Merger Monday has turned into a vicious rally! As the lunch hour comes and goes, the market is approaching a 2% gain for the day! I guess investors are voting with their buy orders that after three down days, the correction is over! All sectors are positive and only 25 stocks are down on the day. The markets have recovered almost 75% of our three-day losses.

The CBOE SPX Volatility Index (VIX) is not coming in as much as you normally would see for a 1.5% rally. Remember volatility is movement higher or lower, so today is actually increasing the historical actual vol of the S&P 500. And the 24-26 range seems to be where implied levels are standing.

Now, checking out the OptionsHouse Hotlist, we have a couple of names in the merger and acquisition headlines.

Xerox (XRX), an announced acquirer today, is buying Affiliated Computer Services (ACS) in a $6.4 billion cash-and-stock deal. Xerox options have traded 65,000 contracts and the stock is lower today, as is often the case.

The options action has been diverse, as my source is showing me conversions, or long stock minus a short call and a long put, trading possibly to get long stock. This could be the work of buywriters possibly looking to enhance yield by giving up some upside. Also the January 2011 7.5/10 strangle is being offered at $2.30. The breakevens for this strangle are the premium collected less the put strike, or $5.20 to the downside, and the premium plus the call strike, or $12.30 to the upside. Inside of these price points the seller keeps all or a portion of the collected premiums. The risk to a short strangle is unlimited to the upside and can be substantially more than the premium collected.

Also on the Hotlist is Abbott Laboratories (ABT), another buyer in the M&A game. The company announced plans to acquire Solvay’s pharmaceuticals business using $6.6 billion in cash. This is accretive to earnings as ABT is not expected to need new debt to finance the purchase, and the shares are higher by 3%.

Among the 60,000 contracts trading, my source is showing me a February 50 call offer – untied at 1.85. This may be a call overwrite, which is exactly the same as a buy write except the trader already owns the long stock. If it is in fact a covered call, the benefit to the seller is pocketing the premium if the shares are below 50 at expiration. The relative risk to a covered call is having the stock called away at the strike and limiting your upside. And of course the actual risk to a covered call is holding long stock, which can trade lower. Yes you are better off on a relative basis overwriting a call than if you are naked long the stock, but don’t forget you definitely want the stock to trade higher.

And that’s what’s hot! Thanks for tuning in and check out the Hotlist every day. And remember in fast markets, fast matters!