Option Investor
Market Updates

Roll Beam, Go Big Blue

HAVING TROUBLE PRINTING?
Printer friendly version

Shares of International Business Machines (NYSE:IBM) are again charging higher. The stock has put together a string of four consecutive days of solid gains -- it's up more than $7 in the last four sessions.

The company reported this morning that it had won a contract over competitor Emc (NYSE:EMC) to supply Wal Mart (NYSE:WMT) with data storage equipment. IBM's win of the contract, which some estimate to be worth tens of millions, reveals what many have suspected recently: IBM is taking market share from EMC.

The data storage market is a big one of which EMC currently controls the majority share. So IBM's win of the Wal Mart contract helps to reveal that the company is, in fact, taking market share from EMC. But was the win of the Wal Mart contract worth a roughly $1.50 move in shares of IBM?

A contract worth tens of millions isn't really that big of a sale for IBM. In the trailing twelve months, IBM recorded revenues of roughly $90 billion. And current estimates are calling for IBM to earn revenues of about $99 billion next year. Again, a contract worth tens of millions is a drop in the bucket of sales for IBM.

IBM's win of the Wal Mart contract may indicate that the company will win future contracts over data storage competitors such as EMC. And that much is probably being discounted in shares of IBM currently. But I think that there's something else at play in the stock, which may help to explain its rally this morning.

Bearish Bets

There are many types of buyers in the marketplace. Some of those buyers are traders who borrowed stock and sold it short, who ultimately have to buy back that borrowed stock at a future time. When a large number of those traders with borrowed stocks grow fearful, the herd mentality takes over and they rush to buyback their borrowed stock, resulting in a sharp rally.

In addition to traditional short-selling of the underlying stock, many bears in the marketplace employ options strategies when betting on a decline in a stock price. The most conventional way of shorting a stock in the options market is through the purchase of a put.

When the buyer of a put sells that contract back to the market maker, the market maker has to, in turn, buy back his/her hedge in the underlying, assuming the market maker wants to remain delta neutral.

Beyond Short Covering

The financial media and traders alike will often explain the source of a stock or broad market rally as short covering. The traditional idea of short covering is that traders who borrowed stock and sold it short are buying back that stock for some reason. But, as I just explained above, short covering can come from the options market.

There are many places on the Web that traders can gain access to dated short sale data. For example, short interest (in the underlying) for IBM currently reveals that 26.9 million shares of the stock had been sold short through September 10. 26.9 million shares is a small amount for IBM -- it's only about 1.5 percent of the stock's float. But, the problem with public short sale data is that it's old, very old.

For a more current insight into bearish bets, traders are better off monitoring the options market. Traders can look for discrepancies and/or imbalances between bullish (call) and bearish (put) bets in the options marketplace. When a stock experiences excessive put buying, the bearish side of the market grows more crowded. And where there's a crowd, there is likely to be a lot more emotion...

IBM FRONT MONTH PUT/CALL SET-UP

The strikes around IBM's recent price range reveal an interesting dynamic. Take note of the excessive open interest in the OCT 95 and 100 puts relative to the open interest in the calls at the accompanying strikes.

So going into Monday's session, following the Wal Mart-related news, those roughly 155,000 puts at the 95 and 100 strikes shed a little more premium. That news may have sparked some fear among the crowded put side, possibly resulting in the holders of those puts selling the contracts and forcing market makers to buy back the underlying, thus IBM's rally this morning.

Eric Utley
Option Investor

Intraday Update Archives