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Tellabs (NASDAQ: TLAB) put volume spikes on volatility bet

By: Jud Pyle
Posted: 6/3/2010 5:01:00 PM
Referenced Stocks: TLAB

Shares of Tellabs Inc. (NASDAQ: TLAB ) are in the red on Thursday without any recent news from the communication equipment producer, and it looks like at least one investor could be betting the downside to continue throughout the near-term judging from heavy put volume on the tape.

TLAB dropped more than 2%, or roughly 21 cents, to $7.85 during midday trading. The company has not had any significant news since its earnings figures on April 27 (the company announced earnings of 11 cents per share, beating estimates by two cents). At the end of April, the company reached a 52-week high of $9.45. In July 2009, TLAB dipped to a 52-week low of under $5, and it looks like at least one investor was willing to risk a hefty amount to bet that the stock could head back toward the lows during the next month.

Around 10:35 a.m. EST, 30,000 TLAB July 7-strike puts changed hands for a premium of 30 cents per contract, which was the ask price at the time of the trade. This options action suggests the investor is calling for the stock to drop at least 10% during the near-term and will make money if TLAB shares are trading lower than $6.70 at July options expiration. If the stock is trading lower than this breakeven, the long put position turns significant but limited profits as the stock nears zero. If TLAB shares remain around their current level, maximum loss is limited to the premium paid, or 30 cents per contract.

At first glance, this trade appears very bearish; it probably is. But a closer look shows that these options traded with stock, meaning that the put buyer simultaneously bought TLAB shares. A look at the time and sales in TLAB shows that 750,000 shares traded at $7.80 around the time of the option trade. 750,000 is roughly the number of shares that market makers would need to sell to make this trade delta neutral. The fact that the investor executed a delta-neutral trade could mean that they are more interested in betting on volatility than direction. The 30-cent premium of the puts with stock at $7.80 equates to an implied volatility of approximately 58%. The 30-day historical volatility of the stock is roughly 58%. If this investor thinks that TLAB will become more volatile, then purchasing options on an implied volatility of 58% will make money for the investor if they are hedged daily until expiration.

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