EQUITY RESEARCHAugust 18, 2005                                                                                            ...
EQUITY RESEARCHIn this note, we screen the S&P 500 to identify stocks having the “richest” options.These stocks currently ...
EQUITY RESEARCHOptions are not suitable for all investors and the risks of option trading should be weighed against the po...
EQUITY RESEARCHImportant Disclosures:The analysts responsible for preparing this report have received compensation based u...
EQUITY RESEARCHarrangement (be it with a client or a counterparty) concerning the shares of such company (e.g. prime broki...
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The Most Expensive Equity Options - Buy or Sell?

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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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The Most Expensive Equity Options - Buy or Sell?

  1. 1. EQUITY RESEARCHAugust 18, 2005 North America Investment Strategy & MacroEquity Derivatives Strategy Equity Derivatives StrategyMarket CommentaryStrategy Ryan Renicker 1.212.526.9425The "Richest of the Rich" rrenicke@lehman.comSector View:New: 0-Not RatedOld: 0-Not RatedInvestment conclusion! During the past couple of weeks, rising crude oil prices have weighed on the U.S. equity market, with the S&P500 declining nearly 200 bps since its 52-week high on August 3rd. (Even with yesterdays 4% decline in crude oil prices, oil prices remain 4% higher than where they traded on August 3rd.) Moreover, this retracement has been broad-based, with 23 of the 24 S&P 500 industry groups trading below their August 3rd levels. In fact, since August 3rd, 387 companies in the S&P 500 (77%) have had declining stock prices. Although U.S. equity risk expectations remain extremely low relative to long-term trends in rolling 3-month S&P 500 implied volatilities, the recent weakness in the equity markets has nudged short-dated implied volatilities higher, despite declining realized volatility. With Q2 earnings largely behind us, and implied volatility currently trading relatively rich versus realized volatility, we believe investors should consider expressing directional viewpoints or hedging existing positions by selling options in companies having the “richest” options. We screen the S&P 500 Index for stocks currently having 3-month implied volatilities trading relatively "rich" versus 1) their 90-day realized volatility and 2) the S&P 500 Index.Figure 1: Returns (8/3/05 – Present) Figure 2: S&P 500 Index Level & Volatility (8/3/05 - Present) Real Estat e 3M Implied - 90D Realized Spread S&P 500 Con Dur&Ap Utilit ies 3.75% 1,250 Retailing Auto & Comp 3.55% Semi & Semi Eqp 1,245 Food/St pl Retail 3.35% Comm Svc&Sup M at erials 3.15% 1,240 Tech Hw & Eqp Telecomm Svcs 2.95% Pharm & Biot 1,235 Energy Hh & Pr Pdt s 2.75% Transpt n 1,230 Banks 2.55% S&P 500 Index Insurance 2.35% 1,225 Fd Bev & Tob Div Financial Sf tw & Svcs 2.15% Cons Srv 1,220 Capit al Gds 1.95% Hc Equip&Svc M edia 1.75% 1,215 08/03/05 08/04/05 08/05/05 08/08/05 08/09/05 08/10/05 08/11/05 08/12/05 08/15/05 08/16/05 08/17/05 Crude Oil-10% -8% -6% -4% -2% 0% 2% 4% 6%Source: Lehman Brothers Equity Derivatives Strategy. Source: Lehman Brothers Equity Derivatives Strategy.Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investorsshould be aware that the Firm may have a conflict of interest that could affect the objectivity of this report.Investors should consider this report as only a single factor in making their investment decisions. PLEASE SEE ANALYST(S) CERTIFICATION(S) ON PAGE 3 AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 4 1
  2. 2. EQUITY RESEARCHIn this note, we screen the S&P 500 to identify stocks having the “richest” options.These stocks currently have 1. 3-month implied volatility spreads versus the S&P 500 at least 1 standard deviation above the average of where this spread has traded during the past year and 2. 3-month implied volatility spreads versus their 90-day realized volatility at least 1 standard deviation above where this spread has traded during the past year.Below, we present the companies that match both of these criteria.Figure 3: S&P 500 Stocks Passing Our “Richest-of-the-Rich” Screen Options "Rich" Versus Expected EPS 90-Day Ticker Name GICS Industry Group Name Last Price S&P 500 Date RealizedADBE UQ ADOBE SYSTEMS INC SOFTWARE & SERVICES 15-Sep-2005 $ 26.83 Yes YesBSC UN BEAR STEARNS COMPANIES INC DIVERS FINANC 22-Sep-2005 $ 99.85 Yes YesWAG UN WALGREEN CO FOOD & STAPLES RETAILING 26-Sep-2005 $ 47.58 Yes YesPEP UN PEPSICO INC FOOD BEV & TOBACCO 30-Sep-2005 $ 54.73 Yes YesJNJ UN JOHNSON & JOHNSON PHARMA & BIOTECH 12-Oct-2005 $ 63.50 Yes YesRDC UN ROWAN COMPANIES INC ENERGY 14-Oct-2005 $ 33.58 Yes YesBR UN BURLINGTON RESOURCES INC ENERGY 20-Oct-2005 $ 64.32 Yes YesEK UN EASTMAN KODAK CO CONS DUR & APPAREL 20-Oct-2005 $ 25.27 Yes YesTMK UN TORCHMARK CORP INSURANCE 20-Oct-2005 $ 51.90 Yes YesXTO UN XTO ENERGY INC ENERGY 20-Oct-2005 $ 35.28 Yes YesED UN CONSOLIDATED EDISON INC UTILITIES 21-Oct-2005 $ 45.93 Yes YesTXU UN TXU CORP UTILITIES 21-Oct-2005 $ 94.76 Yes YesPHM UN PULTE HOMES INC CONS DUR & APPAREL 25-Oct-2005 $ 85.25 Yes YesCOP UN CONOCOPHILLIPS ENERGY 27-Oct-2005 $ 61.70 Yes YesAPA UN APACHE CORP ENERGY 28-Oct-2005 $ 67.43 Yes YesCVS UN CVS CORP FOOD & STAPLES RETAILING 4-Nov-2005 $ 29.19 Yes YesSource: Lehman Brothers Equity Derivatives Strategy.We believe investors should consider expressing directional views or hedging existing positions in these names by selling options. 2
  3. 3. EQUITY RESEARCHOptions 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.Analyst Certification:I, Ryan Renicker, hereby certify (1) that the views expressed in this research Industry Note accurately reflect my personal views about any orall of the subject securities or issuers referred to in this Industry Note and (2) no part of my compensation was, is or will be directly orindirectly related to the specific recommendations or views expressed in this Industry Note. 3
  4. 4. EQUITY RESEARCHImportant Disclosures:The analysts responsible for preparing this report have received compensation based upon various factors including the Firm’s totalrevenues, a portion of which is generated by investment banking activities.Guide to Lehman Brothers Equity Research Rating System:Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (seedefinitions below) relative to other companies 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 the companies that comprise a particular sector coverage universe, please go towww.lehman.com/disclosuresIn addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or3-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 the definitions 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-monthinvestment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a12- 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 firmpolicies in certain circumstances including when Lehman Brothers is acting in an advisory capacity in a merger or strategic transactioninvolving the company.Sector View1-Positive - sector coverage universe fundamentals/valuations are improving.2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.3-Negative - sector coverage universe fundamentals/valuations are deteriorating.Stock Ratings From February 2001 to August 5, 2002 (sector view did not exist):This is a guide to expected total return (price performance plus dividend) relative to the total return of the stocks’ local market (i.e. the marketwhere the stock primarily trades) over the next 12 months.1-Strong Buy - expected to outperform the market by 15 or more percentage points.2-Buy - expected to outperform the market by 5-15 percentage points.3-Market Perform - expected to perform in line with the market, plus or minus 5 percentage points.4-Market Underperform - expected to underperform the market by 5-15 percentage points.5-Sell - expected to underperform the market by 15 or more percentage points.Distribution of Ratings:Lehman Brothers Global Equity Research has 1744 companies under coverage.41% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as Buy rating, 33% ofcompanies with this rating are investment banking clients of the Firm.42% have been assigned a 2-Equal weight rating which, for purposes of mandatory regulatory disclosures, is classified as Hold rating, 7% ofcompanies with this rating are investment banking clients of the Firm.17% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as Sell rating, 86% ofcompanies with this rating are investment 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 beenapproved by Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in theEuropean Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. Thismaterial is distributed in Australia by Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. This material isdistributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regardedas an offer 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 anymanner without the written permission of Lehman Brothers. With the exception of disclosures relating to Lehman Brothers, this research report is based oncurrent public information that Lehman Brothers considers reliable, but we make no representation that it is accurate or complete, and it should not be relied onas such. In the case of any disclosure to the effect that Lehman Brothers Inc. or its affiliates beneficially own 1% or more of any class of common equitysecurities of the subject company, the computation of beneficial ownership of securities is based upon the methodology used to compute ownership underSection 13(d) of the United States Securities Exchange Act of 1934. In the case of any disclosure to the effect that Lehman Brothers Inc. and/or its affiliateshold a short position of at least 1% of the outstanding share capital of a particular company, such disclosure relates solely to the ordinary share capital of thecompany. Accordingly, while such calculation represents Lehman Brothers’ holdings net of any long position in the ordinary share capital of the company, suchcalculation excludes any rights or obligations that Lehman Brothers may otherwise have, or which may accrue in the future, with respect to such ordinary sharecapital. Similarly such calculation does not include any shares held or owned by Lehman Brothers where such shares are held under a wider agreement or 4
  5. 5. EQUITY RESEARCHarrangement (be it with a client or a counterparty) concerning the shares of such company (e.g. prime broking and/or stock lending activity). Any suchdisclosure represents the position of Lehman Brothers as of the last business day of the calendar 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 ofLehman Brothers 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 not be suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothersrepresentative. The value of and the income produced by products may fluctuate, so that an investor may get back less than he invested. Value and incomemay be adversely affected by exchange rates, interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product isincome producing, part of the capital invested may be used to pay that income. © 2005 Lehman Brothers. All rights reserved. Additional information isavailable on request. Please contact a Lehman Brothers entity in your home 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. 5

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