Vioxx setback comes at bad time for Merck

Volume of option trading called `fishy'

Contracts: A surge in activity comes a day before Merck pulls Vioxx from the market.

Questionable Trading

October 01, 2004|By BLOOMBERG NEWS

NEW YORK - Trading in Merck & Co. Inc. stock options that gain in value from a decline in the drugmaker's share price surged Wednesday, a day before the company pulled its Vioxx painkiller from the market.

An investor who Wednesday bought 1,000 options to sell Merck shares at $42.50 by Oct. 16 stood to gain about $1 million by selling them yesterday. The contracts, which fetched 10 cents a share Wednesday, sold for as much as $10 yesterday at the Chicago Board Options Exchange.

Merck shares fell as low as $32.46, a 28 percent drop, in New York Stock Exchange composite trading.

About 2,900 of the so-called put options changed hands Wednesday, more than 22 times the daily average for the past six months.

"It sure does smell fishy," said Pete Najarian, president of Chicago-based Mercury Trading, which acts as a market maker at the Board Options Exchange. "This was pretty extreme as far as the volume of contracts goes."

Merck pulled Vioxx because of a link to heart attacks and strokes. The drug was Merck's No. 4 product last quarter, and its withdrawal forced the company to retract its third-quarter profit forecast and cut its full-year estimate by 50 to 60 cents a share.

Options are the right, but not the obligation, to buy or sell assets at a set price by a certain date. Each stock-options contract controls 100 shares.

Open interest in the October $42.50 puts - the number of contracts that haven't been closed out - rose by 2,044 to 9,500 contracts, showing that most of Wednesday's trades were new bets.

About 2,000 of the contracts changed hands yesterday.

"It would seem that there was some anticipation of the news yesterday - this was not a fluke," said Mike Schwartz, chief options strategist at Oppenheimer & Co. "I am sure the exchange will investigate."

Fred Ruffy, an analyst at Belmont, Calif.-based Optionetics. com, disagreed. Implied volatility in Merck options - a measure of expected swings in the stock price - was little changed Wednesday, signaling that traders didn't anticipate yesterday's tumble.

The ratio of bets on a share-price drop relative to bets on an increase was also little changed, he said.

"One would expect to see an increase in both if the market was expecting the type of stock-moving news that surfaced," Ruffy said in an interview.

He pointed to trades in other Merck options that would have meant losses for the buyer given yesterday's stock decline, including about 7,500 trades this week in contracts that give the holder the right to buy Merck stock at $45 by next month.

The CBOE's department of market regulation "reviews unusual trading activity on a regular basis," said spokeswoman Lynne Howard-Reed. She declined to comment specifically on Merck options. The CBOE is the second-biggest market for the contracts.

Alicia Curran, a spokeswoman for the International Securities Exchange, the biggest market for Merck options, said the ISE routinely reviews trading activity and declined to comment further.

The Pacific Exchange's Dale Carlson also declined to comment.

Joseph Cella, chief of the SEC's Office of Market Surveillance, said the SEC routinely examines trades that precede mergers for signs of insider trading. He said he couldn't confirm the existence of a specific investigation.

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