Options Update: Merrill Lynch Hit with Heavy November Put Volume

Shares of Merrill Lynch (MER | Quote | Chart | News | PowerRating) have fallen more than 7% so far today, as the financial concern is suffering under a fresh wave of selling pressure amid a broad-market decline.

Aside from the weak equities market and recent financial-sector news from Citigroup (C | Quote | Chart | News | PowerRating) and J.P. Morgan Chase (JPM | Quote | Chart | News | PowerRating), there appears to be little driving the stock's losses this afternoon. However, this lack of headline news hasn't stopped a wave of speculation from washing over the shares from options traders.

Specifically, more than 52,000 MER puts have changed hands so far, outpacing the stock's average daily put volume by more than 7.5 to 1. Furthermore, this spike in volume has placed the shares on our Intraday Volume Explosion List. However, it was the more than 29,000 contracts that traded at MER's soon-to-expire November 10 strike that caught my eye today.

The Anatomy of a Merrill Lynch Put Position

If you keep close tabs on the options market, you know that November options expire at the end of this week. So, it came as quite a surprise to see such heavy November put volume on MER with just 3 days until expiration. Drilling down on MER's put volume, I noticed that the activity at the November 10 strike was considerably varied. Several blocks ranging from 100 to 300 contracts changed hands at the ask price or between the ask and bid price.

There was 1 trade that drew my attention immediately, as it totaled a hefty 18,428 contracts. It was the earliest of the large block trades, and crossed the tape at a bid price of $0.29 just after MER breached support at the 11 level - near 10:44 a.m. Eastern time. Open interest at MER's November 10 put totals a mere 4,398 contracts, hinting that this large block trade could be the initiation of a sell-to-open put position. While I will be running with a put-selling theme this afternoon, readers should know that this large block trade could be institutional in nature. As such, the institution initiating the trade could have received a price break on the entry price, thus making a purchased put position appear to be selling activity when compared to the bid-ask spread.

If the contracts were indeed sold, the total credit received would be $534,412 -- ($0.29 * 100)*18,428 = $534,412. Remember that a put-sell trader needs the shares to remain above the sold strike through expiration in order to keep the premium received. In this case, the trader needs MER to stay above $10 per share through the close on Friday. The shares are dangerously close to testing support at the 10 level today, but let's see if the stock's technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

The stock's technical backdrop offers little hope for a put-sell position on MER. The shares have plunged more than 78% so far this year, falling steadily under resistance at their 10-day and 20-day moving averages. Furthermore, this negative price action has gained momentum in the past 2 weeks, with MER dropping 47% since its November 4 peak of $19.99 per share. It is this momentum that should be of most concern to a November 10 put sell trader, as it could quickly place the position in the money, thus causing the trader to be assigned the shares.

There is hope, however, as the 10 level resides just below MER. Not only is this region home to round-number and psychological support, but it is also the site of prior resistance for the equity from March 1994 through February 1995. As I have noted in this space before, former resistance can switch roles and provide support upon a retest of the area. November 10 put sellers are just hoping that this potential support level hasn't grown stale since 1995.

The Sentiment Drivers

MER's sentiment backdrop is also very uninspiring in terms of a put-sell position on the shares. The stock's Schaeffer's put/call open interest ratio (SOIR) of 0.99 ranks below 97% of all those taken during the past year, indicating that options traders have been more optimistic toward MER only 3% of the time in the past year. Should this bullish sentiment unwind as we approach November expiration, it could provide additional selling pressure for the security.

Elsewhere, brokerage firms are straddling the fence on their Wall Street compatriot. According to Zacks.com, all 10 analysts following MER rate the shares a "hold." This middle-of-the-road configuration leaves ample room for both upgrades and downgrades on the security. Unfortunately, with troubles still plaguing the financial sector, the likelihood of upgrades from this neutral bunch seems quite thin. Meanwhile, with MER poised within less than 1 point of the November 10 put, 1 downgrade could be all it takes to place this option in the money.

The Verdict?

After reviewing the sentiment and technical data, I would be more inclined to believe that today's heavy put activity is more focused toward the buying side than the selling side. While the short time frame works to the put seller's advantage, nearly all of our other technical and sentiment indicators do not. Furthermore, should this week's broad market selling pressure continue, MER could easily find itself trading in the single digits by the close of trading on Friday.

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