Risk Premium in Options for the Energy Sector

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Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund managers and other active fund managers worldwide. Ryan Renicker, CFA

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Risk Premium in Options for the Energy Sector

  1. 1. January 31, 2006 Equity Volatility Snapshot Ryan Renicker, CFA • Short-dated implied volatility for the Energy sector is relatively high, even though S&P 500 implied 1.212.526.9425 volatility has retraced from its recent spike.ryan.renicker@lehman.com Devapriya Mallick • Within the Energy sector, we find OIH short-term and forward risk expectations are abnormally 1.212.526.5429 dmallik@lehman.com high relative to the XLE. Moreover, OIH skew is trading rich versus XLE skew. • Lehman U.S. Strategy team recommends overweighting OIH versus XLE. Both are currently trading at all-time highs. An efficient way of expressing this view with options is to write puts on the OIH versus buying puts on the XLE. • We update our Volatility Screen to identify stocks possibly having rich or cheap options. We also update our Earnings Watch to estimate the expected stock price reaction the options market is pricing in for upcoming earnings releases.Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict ofinterest that could affect the objectivity of this report.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them,where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2LEHMAN to request a copy of this research.Investors should consider this report as only a single factor in making their investment decision.PLEASE SEE ANALYST(S) CERTIFICATION AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 7.
  2. 2. Equity Derivatives Strategy | Equity Volatility Snapshot Equity Market Fear Subsides, However . . . The past two weeks have witnessed a dramatic increase, and subsequent decline in risk expectations th for the broad equity market. During the week ending January 20 , 1-month at-the-money (ATM) implied volatility spiked to almost 13%, largely in response to the predominately earnings-driven market sell-off. However, risk expectations have since reverted, as the market rallied last week on the back of solid earnings and forecasts (despite the lower than anticipated Q4 GDP figure released Friday) and SPX 1- month ATM implied volatility currently trades at about 11%. . . . Escalating Risk Expectations for Energy Sector Implied Volatility Relatively High However, the Energy sector’s implied volatility remains relatively high. As Figure 1 illustrates, 3-month ATM implied volatility for the Oil Service HOLDRs Trust (OIH) and the Philadelphia Oil Service Index (OSX), relative to S&P 500 implied volatility, are particularly high. Both have had substantial gains during the past 12 months, with returns of about 77% and 73% respectively (S&P 500 12-month return about 9%). 3-month ATM implied volatility for the Energy Select Sector SPDR Fund (XLE) and the AMEX Natural Gas Index (XNG) are relatively high as well, but have been on a downward trend since reaching their 12-month high in mid November. OIH, XLE Correlation vs. Crude Continues to Climb We also find Energy sector returns have become increasingly correlated1 with crude oil returns. In addition, these correlations have increased as oil prices have increased, particularly since September 2003, when the energy bull market began in earnest (Figure 2). This phenomenon occurred for both the OSX and XLE, even though the XLE includes several integrated oil companies (XOM, CVX, COP: combined weighting in XLE roughly 35%), despite these companies’ exposure to downstream and chemicals operations, where earnings tend to be less correlated with changes in crude oil prices.Figure 1: Energy Implied Volatility High vs. S&P 500 Index Figure 2: OSX, XLE Return Correlation vs. Crude Oil 25% 80% 80 OIH OSX Correl Rolling 90-Day Rtn. Correlation w / Crude Oil Service Sector 70% XLE XLE Correl 70 3-Month Sector - SPX IVOL Spread Risk Expectations Soar OSX 60% Crude 20% XNG 60 50% Crude Oil Price 50 40% 15% 30% 40 20% z 30 10% 10% 20 0% 10 -10% 5% -20% 0 5 5 05 5 5 5 5 5 5 6 5 05 05 0 1 2 3 4 5 0 1 2 3 4 5 6 -0 -0 r-0 -0 -0 -0 l-0 0 0 0 l-0 l-0 l-0 l-0 l-0 l-0 0 0 0 0 0 0 0 g- n- n- n- p- - ay ar ct ov b n- n- n- n- n- n- n- ec Ju Ap Au Ja Ju Ja Fe Ju Ju Ju Ju Ju Ju Se O M M Ja Ja Ja Ja Ja Ja Ja N DSource: Lehman Brothers, OptionMetrics Source: Lehman Brothers, Bloomberg 1 We calculate rolling 90-day correlations using the daily log returns for each ETF/Index vs. those for crude oil prices. January 31, 2006 2
  3. 3. Equity Derivatives Strategy | Equity Volatility Snapshot OIH Risk Expectations Relatively High vs. XLE Buying Downside Protection as Energy Rallies As Figure 3 illustrates, the 3-month 20-delta put – call skew2 for both the XLE and OIH have increased relatively dramatically since May 2005, an indication of investor demand for downside protection for their long positions in the XLE and OIH. However, during the past 3 months, demand for downside protection has continued to accelerate for the OIH, yet decline for the XLE, even though both have continued to rally. From this, we infer that the options market is becoming more risk averse toward the OIH versus the XLE. Although the OIH is fundamentally expected to be more volatile than the XLE (e.g. the investor base in integrated oil companies tends to have longer-term investment horizons), we believe the current divergence in implied volatility skew is abnormal. OIH Forward Implied Volatility Relatively High In Figure 4, we highlight the degree to which the option market is pricing in future short-term risk expectations (specifically, 3-month forward at-the-money implied volatility, in 9 months’ time) for the OIH and XLE. Our findings suggest future short-term risk expectations for the OIH have steadily increased during 2005. On the contrary, forward volatility for the XLE has remained relatively stable. Investment Strategy The Lehman Brothers U.S. Equity Strategy team is currently recommending investors to overweight the OIH relative to an XLE underweight within the broader Energy sector, as they believe the Oil Services industry (OIH) should benefit from significant capital expenditure in energy infrastructure to meet the growing demand for energy through 2007. Please see ETF Monitor, U.S. Strategy, January 27, 2006 for further details. Investors believing the OIH will outperform the XLE should consider taking advantage of the OIH’s relatively “rich” skew and implied volatility versus that of the XLE by writing puts on the OIH versus buying puts on the XLE.Figure 3: Buying Put Protection During OIH Rally, Yet Not for XLE? Figure 4: Future Risk Expectations High for OIH, Not XLE 6% 35% Expected 3M ATM IVOL, in 9 Months Time OIH XLE 20 Delta Put / Call Skew (5D Moving Avg.) 5% OIH Forward Risk Expectations Rising 30% For XLE, Relatively Stable 4% 25% 3% Investors Purchasing Downside Protection for OIH? 2% 20% 1% OIH Forward Vol (9m-12m) XLE Forward Vol (9m-12m) 15% 0% 05 06 5 05 05 05 5 l-0 -0 5 5 05 5 5 5 5 05 05 06 5 05 5 v- n- g- p- c- -0 -0 r-0 -0 -0 -0 l-0 -0 ct Ju g- n- n- n- No p- Ja ay Au Se De ar ct ov b ec Ju Ap O Au Ja Ju Ja Fe Se O M M N DSource: Lehman Brothers, OptionMetrics Source: Lehman Brothers, OptionMetrics 2 We calculate the 20-delta put – call skew by subtracting the at-the-money 3-month 20-delta call implied volatility from the 3-month 20-delta put implied volatility. January 31, 2006 3
  4. 4. Equity Derivatives Strategy | Equity Volatility Snapshot Lehman Brothers Volatility Screen We update the list of stocks identified by the Lehman Brothers Volatility Screen as possibly having rich or cheap options. This screen allows investors to identify potentially rich or cheap one or three month options to efficiently express directional views on the underlying stock or identify attractive long or short volatility trading candidates. Please see Identifying Rich and Cheap Implied Volatility (December 20, 2005) for further details. In Figure 5, we present the current list of stocks having relatively rich options according to the Lehman Brothers Volatility Screen.Figure 5: Stocks Displaying “Rich” Volatility Characteristics Std Devs from Std Devs from Std Devs from Lehman Expected 3-Month Lehman Mean (3-Month Mean (3-Month Mean (3-Month Ticker Name GICS Sector Company Price Earnings Implied Rich/Cheap Sector View Implied vs Implied vs Implied vs S&P Rating Date Volatility Realized) Sector) 500)AAPL APPLE COMPUTER INC Information Technology 2-Equal weight 2-Neutral 75.00 4/13/2006 47% 1.8 1.2 1.5 RichALEX ALEXANDER & BALDWIN INC Industrials 0-Unrated 0-Unrated 52.72 2/1/2006 29% 2.6 1.9 2.1 RichALL ALLSTATE CORP Financials 1-Overweight 1-Positive 52.19 1/31/2006 20% 1.1 2.5 2.6 RichAMH AMERUS GROUP CO Financials 1-Overweight 2-Neutral 61.00 2/1/2006 23% 1.4 1.3 1.5 RichBCR BARD (C.R.) INC Health Care 0-Unrated 0-Unrated 64.45 4/19/2006 24% 1.6 1.7 2.2 RichBEC BECKMAN COULTER INC Health Care 0-Unrated 0-Unrated 59.71 2/17/2006 30% 1.1 2.6 2.6 RichBKH BLACK HILLS CORP Utilities RS-Rating Suspe2-Neutral 35.32 2/7/2006 23% 2.0 2.0 1.9 RichBLC BELO CORPORATION-A Consumer Discretionary 0-Unrated 0-Unrated 22.80 2/9/2006 33% 4.5 4.1 6.7 RichBLI BIG LOTS INC Consumer Discretionary 0-Unrated 0-Unrated 13.45 2/23/2006 38% 1.3 1.4 1.4 RichBSX BOSTON SCIENTIFIC CORP Health Care 1-Overweight 1-Positive 20.90 2/1/2006 47% 3.0 4.5 4.6 RichCAKE CHEESECAKE FACTORY (THE) Consumer Discretionary 2-Equal weight 2-Neutral 36.54 2/7/2006 30% 2.2 2.0 2.4 RichCEY CERTEGY INC Information Technology 1-Overweight 2-Neutral 43.36 4/21/2006 30% 2.0 1.4 1.6 RichDBD DIEBOLD INC Information Technology 0-Unrated 0-Unrated 37.01 1/31/2006 29% 1.2 1.9 2.4 RichEAS ENERGY EAST CORPORATION Utilities 0-Unrated 0-Unrated 24.73 2/10/2006 22% 1.4 1.9 2.1 RichEXC EXELON CORP Utilities 1-Overweight 3-Negative 56.72 4/25/2006 24% 2.3 1.7 1.6 RichFISV FISERV INC Information Technology 3-Underweight 2-Neutral 44.79 4/21/2006 26% 1.4 3.0 2.5 RichFLR FLUOR CORP Industrials 2-Equal weight 2-Neutral 87.70 3/1/2006 28% 1.3 1.1 1.4 RichFPL FPL GROUP INC Utilities RS-Rating Suspe3-Negative 41.64 4/26/2006 19% 1.0 1.2 1.4 RichGOOG GOOGLE INC-CL A Information Technology 1-Overweight 2-Neutral 426.82 1/31/2006 48% 1.6 1.2 1.2 RichHPQ HEWLETT-PACKARD CO Information Technology 1-Overweight 2-Neutral 31.28 2/16/2006 31% 1.5 2.1 2.4 RichJP JEFFERSON-PILOT CORP Financials RS-Rating Suspe2-Neutral 57.61 2/6/2006 25% 4.4 4.4 4.4 RichLEA LEAR CORP Consumer Discretionary 3-Underweight 3-Negative 25.96 4/21/2006 49% 1.4 2.4 2.3 RichLTR LOEWS CORP Financials 0-Unrated 0-Unrated 99.12 2/10/2006 20% 1.6 1.5 1.6 RichMI MARSHALL & ILSLEY CORP Financials 2-Equal weight 2-Neutral 42.10 4/12/2006 18% 2.2 2.2 2.0 RichMYG MAYTAG CORP Consumer Discretionary 0-Unrated 0-Unrated 17.05 2/3/2006 53% 1.7 2.1 2.3 RichOKE ONEOK INC Utilities 1-Overweight 2-Neutral 28.03 2/22/2006 24% 1.6 1.4 1.6 RichPCL PLUM CREEK TIMBER CO Financials 0-Unrated 0-Unrated 37.90 4/25/2006 22% 2.5 1.6 1.7 RichPD PHELPS DODGE CORP Materials 1-Overweight 1-Positive 162.10 1/31/2006 42% 1.0 2.2 2.6 RichRE EVEREST RE GROUP LTD Financials 1-Overweight 1-Positive 100.02 4/18/2006 25% 1.5 3.4 3.2 RichSAFC SAFECO CORP Financials 1-Overweight 1-Positive 53.52 4/19/2006 22% 1.9 2.3 2.3 RichTRB TRIBUNE CO Consumer Discretionary 3-Underweight 3-Negative 29.22 2/1/2006 24% 1.2 1.8 1.8 RichVRX VALEANT PHARMACEUTICALS INTHealth Care 0-Unrated 0-Unrated 17.86 2/24/2006 79% 2.9 3.6 3.6 RichWFSL WASHINGTON FEDERAL INC Financials 3-Underweight 1-Positive 23.95 4/20/2006 21% 1.1 1.0 1.3 RichSource: Lehman Brothers, OptionMetrics, Bloomberg, FAMENote: This screen does not exclude stocks with illiquid options. Investors should consider liquidity before entering into an options position. Stocks that appear as unrated are eithernot covered by Lehman Brothers fundamental analysts or are currently subject to research restrictions. Our universe includes stocks included in either the S&P 500 or the NDX. In Figure 6, we provide the current list of stocks having relatively cheap options according to the Lehman Brothers Volatility Screen.Figure 6: Stocks Displaying “Cheap” Volatility Characteristics Std Devs from Std Devs from Std Devs from Lehman Expected 3-Month Lehman Mean (3-Month Mean (3-Month Mean (3-Month Ticker Name GICS Sector Company Price Earnings Implied Rich/Cheap Sector View Implied vs Implied vs Implied vs S&P Rating Date Volatility Realized) Sector) 500)ACS AFFILIATED COMPUTER SVCS-A Information Technology 1-Overweight 2-Neutral 62.77 4/21/2006 23% -3.0 -2.0 -1.2 CheapATK ALLIANT TECHSYSTEMS INC Industrials 2-Equal weight 1-Positive 77.31 2/2/2006 18% -1.1 -2.2 -1.4 CheapCA COMPUTER ASSOCIATES INTL INCInformation Technology 2-Equal weight 1-Positive 27.73 5/26/2006 22% -1.1 -1.5 -1.1 CheapCI CIGNA CORP Health Care 2-Equal weight 1-Positive 119.25 2/8/2006 23% -1.1 -1.6 -1.1 CheapCMS CMS ENERGY CORP Utilities 2-Equal weight 3-Negative 14.58 2/23/2006 21% -1.8 -1.9 -1.7 CheapFFIV F5 NETWORKS INC Information Technology 1-Overweight 2-Neutral 63.00 4/20/2006 45% -1.5 -1.4 -1.1 CheapHON HONEYWELL INTERNATIONAL INCIndustrials 2-Equal weight 1-Positive 38.03 4/20/2006 20% -1.2 -2.7 -1.3 CheapHPC HERCULES INC Materials 0-Unrated 0-Unrated 11.55 2/2/2006 28% -1.9 -1.7 -1.1 CheapLRCX LAM RESEARCH CORP Information Technology 1-Overweight 1-Positive 46.86 4/13/2006 35% -1.6 -1.6 -1.0 CheapPKI PERKINELMER INC Health Care 0-Unrated 0-Unrated 22.78 4/27/2006 26% -1.6 -1.8 -1.7 CheapPLCM POLYCOM INC Information Technology 1-Overweight 2-Neutral 19.25 4/20/2006 33% -3.2 -2.8 -1.8 CheapPWR QUANTA SERVICES INC Industrials 0-Unrated 0-Unrated 13.77 3/10/2006 39% -1.5 -1.2 -1.0 CheapRTN RAYTHEON COMPANY Industrials 2-Equal weight 1-Positive 41.62 2/2/2006 15% -1.2 -1.8 -1.1 CheapSMTC SEMTECH CORP Information Technology 2-Equal weight 1-Positive 19.20 3/1/2006 33% -3.1 -2.4 -1.7 CheapSource: Lehman Brothers, OptionMetrics, Bloomberg, FAMENote: Acquisition targets with very low volatility have been removed from this list. Stocks that appear as unrated are either not covered by Lehman Brothers fundamental analysts orare currently subject to research restrictions. Our universe includes stocks included in either the S&P 500 or the NDX. January 31, 2006 4
  5. 5. Equity Derivatives Strategy | Equity Volatility Snapshot Earnings Watch: Companies Reporting 1/24 – 1/30 We incorporate implied volatility information to ascertain the expected stock price reaction priced in by the options market for upcoming earnings announcements. Please see Options Strategy Monthly: th Low Volatility in the 7 Inning? (January 10, 2006) for further details. In Figure 7, we present this week’s edition of the Earnings Watch.Figure 7: Expected Absolute Stock Price Reactions to Upcoming Earnings Announcements Average Absolute Stock Price Average Stock Price Move Expected Implied 1-day Stock Ticker Name Price (1/23/06) Move Following Earnings Following Earnings Earnings Date Price Move Announcements AnnouncementsACE ACE LTD 31-Jan-06 54.96 1.8% 2.0% 1.7%ALL ALLSTATE CORP 31-Jan-06 52.19 3.1% 1.3% -0.4%AW ALLIED WASTE INDUSTRIES INC 31-Jan-06 9.11 2.1% 7.2% -1.3%CB CHUBB CORP 31-Jan-06 94.94 1.6% 2.4% 1.5%CFC COUNTRYWIDE FINANCIAL CORP 31-Jan-06 34.25 4.5% 3.5% -1.1%CHIR CHIRON CORP 31-Jan-06 44.99 1.1% 1.9% 0.8%HLT HILTON HOTELS CORP 31-Jan-06 25.29 2.0% 1.5% -1.0%ITW ILLINOIS TOOL WORKS 31-Jan-06 88.53 1.2% 2.0% -1.1%K KELLOGG CO 31-Jan-06 43.68 2.5% 2.0% 0.2%NAV NAVISTAR INTERNATIONAL 31-Jan-06 27.30 4.1% 5.4% -1.4%NI NISOURCE INC 31-Jan-06 20.25 1.0% 1.2% -0.3%SYMC SYMANTEC CORP 31-Jan-06 18.19 7.1% 5.6% -2.7%VMC VULCAN MATERIALS CO 31-Jan-06 72.50 2.9% 1.3% -0.1%BA BOEING CO 01-Feb-06 69.03 1.7% 1.4% 0.7%BUD ANHEUSER-BUSCH COS INC. 01-Feb-06 42.01 2.5% 1.3% -0.8%DUK DUKE ENERGY CORP 01-Feb-06 28.37 1.6% 1.8% 0.5%EQR EQUITY RESIDENTIAL 01-Feb-06 42.45 2.1% 1.2% -1.1%HCA HCA INC 01-Feb-06 49.25 2.0% 1.6% 0.3%JDSU JDS UNIPHASE CORP 01-Feb-06 3.12 6.2% 8.3% -4.6%MBI MBIA INC 01-Feb-06 62.68 1.8% 1.9% 0.7%MNST MONSTER WORLDWIDE INC 01-Feb-06 43.60 5.6% 4.1% -2.0%PBI PITNEY BOWES INC 01-Feb-06 42.52 2.2% 1.0% 1.0%PCAR PACCAR INC 01-Feb-06 74.42 2.0% 2.2% -0.2%PHM PULTE HOMES INC 01-Feb-06 39.79 1.8% 4.2% 2.3%PNW PINNACLE WEST CAPITAL 01-Feb-06 42.52 0.6% 0.9% -0.8%PPL PPL CORPORATION 01-Feb-06 29.72 1.0% 1.7% 0.7%SBUX STARBUCKS CORP 01-Feb-06 31.87 3.3% 3.3% 2.0%SUN SUNOCO INC 01-Feb-06 96.21 1.3% 1.6% 0.3%TRB TRIBUNE CO 01-Feb-06 29.22 1.8% 2.1% -0.1%XEL XCEL ENERGY INC 01-Feb-06 19.28 2.9% 1.0% 0.4%AGN ALLERGAN INC 02-Feb-06 115.78 2.4% 3.8% 0.0%APCC AMERICAN POWER CONVERSION 02-Feb-06 24.01 6.3% 12.0% -1.4%AVP AVON PRODUCTS INC 02-Feb-06 28.17 4.3% 6.7% -0.2%CLX CLOROX COMPANY 02-Feb-06 58.13 2.0% 2.7% -1.5%CMCSA COMCAST CORP-CL A 02-Feb-06 27.81 2.0% 2.7% -1.6%CVS CVS CORP 02-Feb-06 27.86 4.0% 3.5% 2.8%EC ENGELHARD CORP 02-Feb-06 40.55 1.4% 2.5% 0.7%EFX EQUIFAX INC 02-Feb-06 38.15 0.2% 2.6% 1.4%EOG EOG RESOURCES INC 02-Feb-06 83.42 1.9% 2.7% 0.5%EOP EQUITY OFFICE PROPERTIES TR 02-Feb-06 31.67 2.7% 1.4% -0.4%ERTS ELECTRONIC ARTS INC 02-Feb-06 56.35 3.7% 4.9% -0.3%GR GOODRICH CORP 02-Feb-06 39.58 2.6% 4.3% -1.3%GTW GATEWAY INC 02-Feb-06 2.76 2.6% 9.0% -1.7%HOT STARWOOD HOTELS & RESORTS 02-Feb-06 61.58 1.6% 2.7% 0.5%HPC HERCULES INC 02-Feb-06 11.55 1.6% 2.9% -0.9%MEDI MEDIMMUNE INC 02-Feb-06 33.26 0.9% 3.3% 1.9%ROH ROHM AND HAAS CO 02-Feb-06 50.81 1.8% 2.9% 1.4%RTN RAYTHEON COMPANY 02-Feb-06 41.62 1.4% 1.5% 0.6%SLE SARA LEE CORP 02-Feb-06 18.37 1.4% 3.3% -0.7%SNA SNAP-ON INC 02-Feb-06 39.95 2.0% 3.1% 1.8%STA ST PAUL TRAVELERS COS INC/TH 02-Feb-06 46.25 2.2% 2.3% 0.9%TMO THERMO ELECTRON CORP 02-Feb-06 33.34 1.1% 3.8% -1.4%TSG SABRE HOLDINGS CORP-CL A 02-Feb-06 24.54 1.6% 4.8% 1.1%TXU TXU CORP 02-Feb-06 50.90 4.0% 4.1% 0.2%TYC TYCO INTERNATIONAL LTD 02-Feb-06 26.53 0.8% 4.2% -1.0%AES AES CORP 03-Feb-06 17.00 2.2% 3.9% 1.2%MCO MOODYS CORP 03-Feb-06 64.50 1.8% 2.3% -0.6%R RYDER SYSTEM INC 03-Feb-06 44.43 2.0% 2.7% 0.7%WEN WENDYS INTERNATIONAL INC 03-Feb-06 58.75 2.8% 2.8% 0.0%WHR WHIRLPOOL CORP 03-Feb-06 81.20 2.5% 3.1% -0.2%WY WEYERHAEUSER CO 03-Feb-06 70.38 1.5% 2.3% -1.1%DIS THE WALT DISNEY CO. 06-Feb-06 25.46 1.5% 3.4% 1.0%HAS HASBRO INC 06-Feb-06 21.34 1.8% 1.7% -1.4%HUM HUMANA INC 06-Feb-06 56.40 3.7% 3.7% 1.2%LPX LOUISIANA-PACIFIC CORP 06-Feb-06 29.41 4.0% 4.6% 1.4%NBR NABORS INDUSTRIES LTD 06-Feb-06 82.31 2.2% 2.7% 1.0%PFG PRINCIPAL FINANCIAL GROUP 06-Feb-06 47.73 1.9% 2.5% -0.4%SPG SIMON PROPERTY GROUP INC 06-Feb-06 83.00 0.9% 1.9% 1.9%TIN TEMPLE-INLAND INC 06-Feb-06 46.69 3.3% 1.4% 0.6%YUM YUM! BRANDS INC 06-Feb-06 49.74 2.9% 3.3% 1.2%Source: Source: Lehman Brothers, BloombergNote: This list does not exclude illiquid options. Investors should consider liquidity of options before entering a trade. For details on the methodology we use to calculate the impliedstock price move, please see “Earnings Impact on Implied and Realized Volatility”, included in the Options Strategy Monthly, January 10, 2006. January 31, 2006 5
  6. 6. Equity Derivatives Strategy | Equity Volatility Snapshot Volatility Screen User Interface Obtain Implied Volatility Analytics for an Individual Stock Screen Universe for Rich/Cheap Volatility, By Sector, Analyst Rating, Earnings Period Implied and Realized Volatility Implied and Realized Rich/Cheap Indicators for for Individual Stock Screened Individual Stock ScreenedNote: Stocks that appear as unrated are either not covered by Lehman Brothers fundamental analysts or are currently subject to research restrictions. Volatility Screen Summary Output Number of Standard Deviations Above or Below Spreads’ 2-Year Average Current 1-Month If > 1 then “Rich”. If < -1 then “Cheap” Implied Volatility Rich/Cheap Metrics: Rich/Cheap Metrics: Company Details 1-Month 3-Month Implied Volatility Implied Volatility January 31, 2006 6
  7. 7. Equity Derivatives Strategy | Equity Volatility SnapshotAnalyst Certification:The respective research analysts responsible for the fundamental ratings hereby certify (1) that the views expressed in this research email accurately reflect ourpersonal views about any or all of the subject securities or issuers referred to in this email and (2) no part of our compensation was, is or will be directly or indirectlyrelated to the specific recommendations or views expressed in this email.I, Ryan Renicker, hereby certify (1) that the views expressed in this research email accurately reflect my personal views about any or all of the subject securities orissuers referred to in this email and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressedin this email.To the extent that any of the conclusions are based on a quantitative model, Lehman Brothers hereby certifies (1) that the views expressed in this research emailaccurately reflect the firms quantitative research model (2) no part of the firms compensation was, is or will be directly or indirectly related to the specificrecommendations or views expressed in this research report.Important DisclosuresLehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have aconflict of interest that could affect the objectivity of this email communication.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost tothem, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2-LEHMAN to request a copy ofthis research.Investors should consider this communication as only a single factor in making their investment decision.The analysts responsible for preparing this report have received compensation based upon various factors including the Firm’s total revenues, a portion of which isgenerated by investment banking activities.Stock price and ratings history charts along with other important disclosures are available on our disclosure website at www.lehman.com/disclosuresAnd may also be obtained by sending a written request to: LEHMAN BROTHERS CONTROL ROOM , 745 SEVENTH AVENUE, 19TH FLOOR NEW YORK, NY10019Options are not suitable for all investors and the risks of option trading should be weighed against the potential rewards.Supporting documents that form the basis of the recommendations are available on request. Please note that the trade ideas withinthis report in no way relate to the fundamental ratings applied to European stocks by Lehman Brothers Equity Research.Guide to Lehman Brothers Equity Research Rating SystemOur coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (see definitions below) relative to othercompanies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (“the sector coverage universe”). To see a list of companies thatcomprise a particular sector coverage universe, please go to www.lehman.com/disclosures.In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below).A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including thedefinitions of all ratings and not infer its contents from ratings alone.Stock Rating1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstancesincluding when Lehman Brothers is acting in an advisory capacity on a merger or strategic transaction involving the company.Sector View1-Positive - sector coverage universe fundamentals are improving.2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating.3-Negative - sector coverage universe fundamentals are deteriorating. January 31, 2006 7
  8. 8. Equity Derivatives Strategy | Equity Volatility SnapshotDistribution of Ratings:Lehman Brothers Equity Research has 1841 companies under coverage.42% have been assigned a 1-Overweight rating which, for purposes of mandatory disclosures, is classified as a Buy rating, 35% of companies with this rating are investmentbanking clients of the Firm.41% have been assigned a 2-Equal weight rating which, for purposes of mandatory disclosures, is classified as a Hold rating, 6% of companies with this rating areinvestment banking clients of the Firm.17% have been assigned a 3-Underweight rating which, for purposes of mandatory disclosures, is classified as a Sell rating, 72% of companies with this rating areinvestment banking clients of the Firm.This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (“Lehman Brothers”) and has been approved byLehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in the European EconomicArea. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. This material is distributed in Australiaby Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. (“LBIS”). Where this material is distributed by LBIS, pleasenote that it is intended for general circulation only and the recommendations contained herein does not take into account the specific investment objectives, financialsituation or particular needs of any particular person. An investor should consult his Lehman Brothers’ representative regarding the suitability of the product and takeinto account his specific investment objectives, financial situation or particular needs before he makes a commitment to purchase the investment product. This materialis distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regarded as anoffer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in any mannerwithout the written permission of Lehman Brothers. With the exception of disclosures relating to Lehman Brothers, this research report is based on current publicinformation that Lehman Brothers considers reliable, but we make no representation that it is accurate or complete, and it should not be relied on as such. In the caseof any disclosure to the effect that Lehman Brothers Inc. or its affiliates beneficially own 1% or more of any class of common equity securities of the subject company,the computation of beneficial ownership of securities is based upon the methodology used to compute ownership under Section 13(d) of the United States SecuritiesExchange Act of 1934. In the case of any disclosure to the effect that Lehman Brothers Inc. and/or its affiliates hold a short position of at least 1% of the outstandingshare capital of a particular company, such disclosure relates solely to the ordinary share capital of the company. Accordingly, while such calculation representsLehman Brothers’ holdings net of any long position in the ordinary share capital of the company, such calculation excludes any rights or obligations that LehmanBrothers may otherwise have, or which may accrue in the future, with respect to such ordinary share capital. Similarly such calculation does not include any sharesheld or owned by Lehman Brothers where such shares are held under a wider agreement or arrangement (be it with a client or a counterparty) concerning the sharesof such company (e.g. prime broking and/or stock lending activity). Any such disclosure represents the position of Lehman Brothers as of the last business day of thecalendar month preceding the date of this report.This material is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion of LehmanBrothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, and they may notbe suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothers representative. The value of and theincome produced by products may fluctuate, so that an investor may get back less than he invested. Value and income may be adversely affected by exchange rates,interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product is income producing, part of the capital invested may beused to pay that income. © 2006 Lehman Brothers. All rights reserved. Additional information is available on request. Please contact a Lehman Brothers entity in yourhome jurisdiction.Lehman Brothers policy for managing conflicts of interest in connection with investment research is available at www.lehman.com/researchconflictspolicy. Ratings,earnings per share forecasts and price targets contained in the Firms equity research reports covering U.S. companies are available atwww.lehman.com/disclosures.Complete disclosure information on companies covered by Lehman Brothers Equity Research is available at www.lehman.com/disclosures. January 31, 2006 8

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