Fretful traders seek Lehman puts, see share swings

By Doris Frankel

CHICAGO (Reuters) - Option investors braced for more share price turbulence in investment bank Lehman Brothers Holdings Inc LEH.N on Tuesday, with many seeking put options on the view that the shares could fall further.

Shares of Lehman, the No. 4 U.S. investment bank, skidded as much as 40 percent and were on track for their biggest daily percentage decline ever.

News that talks about a possible investment from Korea Development Bank had broken down ignited the selling, which continued after Standard & Poor's rating agency warned that Lehman's falling share price heightened uncertainty about the bank's ability to raise additional capital and may prompt it to cut Lehman's credit rating.

"Earlier in the session, option traders seemed to have lost patience with the fruitless talks between Lehman Brothers and Korea Development Bank. As a result, put options were in greater demand compared to calls," said Rebecca Engmann Darst, equity options analyst at Interactive Brokers Group.

A put option allows an investor to sell the company's shares at a specific price and time, while a call conveys the right to buy the shares at a given price and time.

In afternoon trading, shares of Lehman Brothers dropped 39.15 percent at $8.61 after falling to $8.50, their lowest level since October 1998, Reuters data showed.

The worries over Lehman spilled over into the options market. Lehman's option volume swelled to five times the normal level, with puts outpacing calls by a factor of 1.71, according to option analytics firm Trade Alert. Roughly 477,000 puts compared to 280,000 calls changed hands late in the day.

"There is massive put buying," said Pete Najarian, a founder of web information site optionmonster.com.

"It appears that speculation is building that Lehman needs to find some capital soon. Some option traders seem to be expecting the stock price to suffer further declines if that capital infusion does not happen between now and the end of the year," Najarian said.

He said the most aggressive put buying was in the January 2009 $5 puts as well as the October $10 puts. The January $5 puts, for example, traded 53,397 contracts compared to open interest of 13,590 lots and fetched $1.76 a contract.

Additionally, put strikes from $2.50 to up $10 were active across September, October and January contracts," he said.

The rush to buy options pushed Lehman's projected option volatility -- the expected magnitude of share price movement -- to an all-time high, suggesting more risk of share price turbulence than its shares have shown in the past, Interactive Brokers' Darst said.

Lehman's overall implied volatility stood at 311.7 percent, just off its highs of 313.9 percent earlier in the session, according to Interactive Brokers data.

A look at Lehman's September $10 straddle, an options volatility bullish trade, suggests shares could rise or fall by as much as $5 over the next 11 days, Darst said.

(Editing by Leslie Adler)