Wednesday Options Outlook: AIG, LM, RL, XRAY, ALNY, EXPE, MAS, XLF, CSCO

American International Group (AIG) –An early-session 20% spike in AIG’s implied volatility to 46% speaks to roiling tensions beneath the surface of a $35 share price (down 4.5% - and itself a new 52-week low). The move came after a Citigroup analyst suggested that AIG’s capital-raising efforts heretofore may not be adequate and intimated that the company would resort to anything to avoid another ratings downgrade. We saw immediate fallout in the options market in two-way traffic in June 35 calls, which are trading at nearly 3 times the open interest. Fresh volume was also observed at the same strike in the puts, albeit mostly to buyers. Elsewhere we noticed long interest at the July 38 call line and 39 put line on disparate volumes, making it hard to rule this a long-volatility strangle. The 35 line also attracted activity in the August contract, with the predominance of sellers on the call side and buyers on the put side giving voice to a very unsettling outlook into the “summer-after-subprime” outlook for AIG indeed.

Legg Mason (LM) – Ominous out-of-the-money put spread activity in the July contract has sent overall trading activity to 8.5 times the normal level in early trading. Legg Mason shares are down 1.1% to $53.07, but it looks as though a trader entered a 8,520-lot long (bearish) put spread in the July contract, taking a meager 15-cent credit on the sale of 40-strike puts to defray part of the cost of the 75-cent 45-strike puts. The higher strike still represents a 14% comedown from the 52-week low. Implied volatility at 37.5% shows marginal elevation above the 33.4% historic reading on Legg Mason shares but has evinced little movement intraday.

Polo Ralph Lauren (RL) – came as out of left field, spurred on by the success of its ambitiously mainstream “American Living” line for J.C. Penney (JCP) and solid European sales. While shares rose 11% to $68.50, many options traders took a more cynical tack in trading in rise in its shares, sending volume to 11 times the normal level as the equivalent of half its open interest was actively deployed. Polo Ralph Lauren was the largest relative volume gainer on our platform as of the noon hour. Activity in the June contract showed an inclination among traders to sell premium at the 65 and 70 call strikes, and in puts at the 65 strike. Activity in the summer option calendar showed at least one trader staking a prediction on rangebound activity by selling a 5,000-lot strangle between the 65 puts and 70 calls, taking in $5.25 in premium on the notion that Polo Ralph Lauren shares will remain staked between those strike prices through July. The current share price is still $34 off its 52-week high.

DENTSPLY International (XRAY) – Last week we noted a penchant among some option traders to make quirky bets on a number of dental technology stocks – among them Align Technology (ALGN) and Sirona Dental Systems (SIRO) – which seemed to follow on from a premise presented by legendary short seller Doug Kass and his bearish theory on the sector, given its increasing dependence on out-of-pocket spending. It was with this still fresh in mind that we observed today’s increase in option trading volume to 22.5 times the normal level in yet another dental technology stock, DENTSPLY International. The company’s product palette includes, as the ticker would suggest, digital x-ray equipment and intra-oral cameras, as well as prosthetics and sealants. Shares in the company are down 1% to $40.52 today, trending with a near-10% decline for the year to date, and while the implied volatility reading (24%) shows some arrearage at least compared to the 31% historic volatility reading on the underlying stock, it looks as though some traders picked today to short volatility at the October 40 line. The combined price of this position at $5.30 is still 13% of the current share price, and represents the maximum profit to be gained for the trader if DENTSPLY shares remain at the present level heading into the fall, rending neither the put nor the call worthy of exercise.

Alnylam Pharmaceuticals (ALNY) – One day after it was reported that the company could gain as much as $1 billion from lucrative licensing deals with Japan’s largest drug producer, Takeda, we noted an increase in option trading volume to 7 times the normal level in US-based genetics drugmaker Alnylam. This occurred against very minimal share price action in the stock, which is down .67% today to $28.26. While today’s activity is situated firmly in out-of-the-money calls, we feel compelled to note that this looks like short call-spread activity, which muddies the outlook quite a bit. It looks like the 2,000-lot spread position involved the sale of September 35 calls for $1.20, balanced with the purchase of 45 calls for 40 cents, resulting in a 75-cent credit on the transaction that represents the maximum profit on the transaction.

Expedia (EXPE)  – Early-session murmurings that IAC/InteractiveCorp (IACI) chairman Barry Diller might look to take Expedia private made their way to Briefing.com as shares in the online travel bazaar rose 7.5% to $23.35 and a rush to buy June calls at the 22.50 and 25 strikes sent option volume to nearly 5 times the normal level. Implied volatility is up some 27.5% on the session to 45.5%, making it one of the day’s top volatility gainers among tickers trading on a volume in excess of 1,000 lots.

Masco (MAS)  -   Fresh, out-of-the-money call buying in the January contract in Masco, the maker of faucets, cabinets and builders’ hardware, grabbed our attention, as it propelled overall option volume to nearly 5 times the normal level as shares rose 3.5% to $18.33. We can confirm that the 4,000 lots chalked at the January ’09 25 call strike were bought on the offer for 45 cents, implying a return to price levels not seen in Masco Corp since September 2007. Bear in mind that this activity comes barely 4 weeks after the company reported dismal Q1 profits and cut its full-year guidance, expecting industry conditions to remain “challenging” for several quarters as it predicted an additional 25-33% decline in 2008 housing starts. Also last month, the company drew a ratings downgrade on its issuer default, senior unsecured debt, and secured bank facility ratings from Fitch owing to the lackluster U.S. housing market.

Financial Select Sector SPDR (XLF)  – A 1.2% decline in the value of the financial sector ETF to $24.50 has more than 183,000 options trading in the first 90 minutes of the market. Despite a largely even volume distribution between puts and calls, early notable action showed a predilection for bullish position. In support of this we submit heavy buying interest in July 27 calls for 33 cents apiece, predicting a return to price levels last visited in the sector ETF during the first week of May. Heavy action is occurring at either side of the June 25 line, with the 40,000 lots active on the call side matching up to nearly one-fifth of the open interest at that strike, and with buyers outranking sellers by 2-to-1. This combines with heavy selling pressure at the 25 put strike for $1.20. It is unclear whether this is outright straddle selling in anticipation of a comedown in volatility and rangebound price action, or if the long calls are involved with the sold puts in synthetic long positioning.

Cisco (CSCO) – Shares in Cisco exhibited a meager .39% decline to $25.49 today but its nearly 66,000 active contracts made it an early mover among the top-volume tickers on our platform. With puts outmoving calls by nearly 3 to 1, we saw exorbitant two-way traffic at the June 28 put line, but heavy outright buying at the July 27.50 put line amounting to about half the open interest at that strike. While we cannot say firmly that the position represents fresh buying, the fact that the $2.38 premium represents an 8% increase from yesterday’s levels and roughly twice the price the last time seven-digit trading volumes were seen at this strike makes one wonder why a trader would close out an existing short position at a loss.  The ratio of calls to puts in Cisco continues to favor the calls by a factor of 1.2.

Rebecca Engmann Darst contributed to this report.