Equity Volatility - Trends in Volatility Regimes

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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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Equity Volatility - Trends in Volatility Regimes

  1. 1. January 24, 2006 Equity Volatility Snapshot Ryan Renicker, CFA • During the past couple of weeks, and particularly last Friday, a host of Q4 earnings 1.212.526.9425 disappointments and macroeconomic issues such as high crude prices weighed heavily on theryan.renicker@lehman.com stock market. Devapriya Mallick 1.212.526.5429 • We examine option volume trends during last week’s expiration and compare them with volume dmallik@lehman.com profiles leading up to expirations in 2005. We find that the total volume of option contracts traded tends to increase steadily as expiration approaches, and also tends to be relatively high during periods of heightened risk aversion (such as last Friday). • During the following 5 trading days, approximately 150 companies in the S&P 500 are expected to report earnings. The industry groups having the largest number of companies reporting are Health Care Equipment & Services and Capital Goods. • We update the list of stocks identified by the Lehman Brothers Volatility Screen as possibly having rich or cheap options. We also update the Lehman Brothers Earnings Watch to estimate the expected stock price reaction the options market is pricing in for upcoming earnings announcements.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 8.
  2. 2. Equity Derivatives Strategy | Equity Volatility Snapshot Market Fear Escalates: Growing Pains? As we enter the heart of the Q4 earnings season, a host of recent Q4 earnings disappointments (INTC, YHOO, MOT, GE) as well as macro factors such as high crude oil prices have weighed heavily on the stock market during the past couple of weeks. This is in stark contrast to the relatively optimistic earnings growth outlook investors appear to have had at the beginning of the year. Investor optimism ahead of the Q4 earnings season had contributed to the market’s initial rally and decline in implied volatility. In fact, from December 30, 2005 to January 11, 2006, the S&P 500 gained nearly 4%, and 1-month S&P 500 implied volatility approached multi- year lows, settling at about 10% on January 11. However, recent negative events have led to a noticeable increase in short-term risk expectations for the U.S. equity market, as 1-month S&P 500 at-the-money implied volatility rose nearly 2 vol points on Friday alone as the market declined (Figure 1). Earnings Reports This Week As Figure 2 illustrates, approximately 150 companies in the S&P 500 Index are expected to report earnings during the next 5 trading days. Health Care Equipment and Services (WLP, CAH, GDT) and Capital Goods (CAT, HON, LMT) are the industry groups having the largest number of companies reporting in the coming week.Figure 1: SPX Index vs. SPX 1-Month Implied Volatility Figure 2: EPS Releases for the Coming Week by Industry Group S&P 500 Industry Group # Reporting % of Total 16% Health Care Equipment & Services 18 11.9% 1,290 Capital Goods 17 11.3% 15% 1,270 Materials 13 8.6% Technology Hardware & Equipment 11 7.3% SPX 1-Month ATM IVOL 14% 1,250 Consumer Durables & Apparel 10 6.6% S&P 500 Index 13% Energy 10 6.6% 1,230 Software & Services 10 6.6% 12% Pharmaceuticals & Biotechnology 8 5.3% 1,210 Semiconductors & Semiconductor Equipment 8 5.3% 11% 1,190 Utilities 6 4.0% Diversified Financials 5 3.3% 10% 1,170 Household & Personal Products 5 3.3% 9% 1-Month SPX IVOL Insurance 5 3.3% 1,150 S&P 500 Index Media 5 3.3% 8% 1,130 Food, Beverage & Tobacco 4 2.6% Transportation 4 2.6% 5 5 05 5 5 5 5 5 06 Telecommunication Services 3 2.0% 5 05 5 -0 -0 r-0 -0 -0 l-0 0 0 -0 g- n- n- n- p- ay ar ov b ec Ju Ap Banks 2 1.3% Au Ja Ju Ja Fe Se M M N D Commercial Services & Supplies 2 1.3% Automobiles & Components 1 0.7% Consumer Services 1 0.7% Food & Staples Retailing 1 0.7% Real Estate 1 0.7% Retailing 1 0.7%Source: Lehman Brothers, Bloomberg Source: Lehman Brothers, Bloomberg Record Option Volumes on January Expiration Equity options and PM-settled index options expire on the Friday preceding the third Saturday of each month. These expiration dates typically have a relatively high volume of option contracts traded. In addition, increased hedging activity can impact the performance and volume of the underlying stocks. We examine option volume trends during last week’s expiration and compare them with volume profiles around expirations in 2005. Since the January expiration week is the only one in the year having four trading days, we analyze 2005 expiration week volumes from Tuesday to Friday for consistency. January 24, 2006 2
  3. 3. Equity Derivatives Strategy | Equity Volatility Snapshot We find that the total volume of option contracts traded tends to increase steadily as expiration approaches (Figure 3). This has been true since 2005 for single-stock options as well as options on the S&P 500 Index. Since the macroeconomic and earnings-related concerns during last Friday’s expiration were significant, one would expect above average option activity on that day. Figure 4 shows this indeed was the case; on Friday alone, over 6.5 million option contracts traded on stocks in the S&P 500. This is similar to what occurred during last April’s expiration, when heightened risk aversion following a series of negative market impact events corresponded with high option volumes.Figure 3: Equity and Index Option Volumes in Expiration Week Figure 4: Equity Options Volume on Expiration Days 3.5 600 7,000,000 Average Equity Option Volume (LHS) Option Volume on Expiration Option volum e 6,000,000 Highest SPX Index Option Volume (000 Average SPX Option Volume (RHS) 500 peaks on credit Volum e Ever Equity Option Volume (Mn concerns 5,000,000 400 Contracts) Contracts) 4,000,000 3.0 300 3,000,000 200 2,000,000 100 1,000,000 2.5 0 0 Expiration - 3 Expiration - 2 Expiration - 1 Expiration Date 05 5 05 05 06 05 5 05 5 5 5 05 05 l-0 -0 -0 -0 -0 p- - n- n- n- b- g- r- ov ec ay ar ct Ju Days to Expiration Ja Ju Ja Fe Ap Se Au O M N D MSource: Lehman Brothers, OptionMetrics Source: Lehman Brothers, OptionMetrics We compare last Friday’s single-stock option volume for each sector with their respective average year-to-date option volumes. We find volume increased consistently across the majority of sectors on Friday, with option contracts on stocks belonging to the Energy and Industrials sectors trading, on average, nearly two times their average year-to-date volume (Figure 5). The CBOE index put/call ratio can be considered a bearish sentiment indicator, since a higher ratio suggests investors are purchasing more put contracts to provide downside protection for their portfolios. We find that the average volume of index puts increased steadily throughout last week, and peaked on Friday (Figure 6). This implies much of Friday’s options activity could have been driven by investors buying downside protection.Figure 5: Change in Contract Volume by Sector Figure 6: Rising Index Put/Call Ratios Average YTD Volume on Change in Sector 1.60 2,000,000 Volume Friday Volume (%) Volume of Puts Traded (RHS)Energy 12,093 24,023 99%Industrials 5,846 11,580 98% Put/Call Ratio (22-day Avg) 1,600,000 1.50Utilities 954 1,803 89%Health Care 7,789 12,061 55% 1,200,000Information Technology 18,826 27,183 44%Consumer Discretionary 7,067 10,148 44% 1.40Financials 8,685 11,615 34% 800,000Materials 6,011 6,545 9% 1.30Consumer Staples 11,972 9,700 -19% 400,000Telecommunication Services 22,295 8,664 -61% 1.20 0 6 6 6 6 06 06 06 /0 /0 /0 /0 3/ 5/ 9/ 11 13 18 20 1/ 1/ 1/ 1/ 1/ 1/ 1/Source: Lehman Brothers, OptionMetrics Source: CBOE January 24, 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 potentially attractive long or short volatility trading candidates. Please see Identifying Rich and Cheap Implied Volatility (December 20, 2005) for further details. In Figure 7, we present the current list of stocks having relatively rich options according to the Lehman Brothers Volatility Screen.Figure 7: 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)ACV ALBERTO-CULVER CO Consumer Staples 0-Unrated 0-Unrated 43.87 1/26/2006 25% 1.7 2.1 1.9 RichADTN ADTRAN INC Information Technology 1-Overweight 2-Neutral 31.43 4/18/2006 47% 1.2 2.0 1.5 RichALEX ALEXANDER & BALDWIN INC Industrials 0-Unrated 0-Unrated 51.90 2/1/2006 30% 2.3 1.9 1.8 RichAMH AMERUS GROUP CO Financials 1-Overweight 2-Neutral 60.00 2/1/2006 24% 1.2 1.3 1.2 RichBCR BARD (C.R.) INC Health Care 0-Unrated 0-Unrated 64.28 1/25/2006 25% 1.9 1.6 1.7 RichBEC BECKMAN COULTER INC Health Care 0-Unrated 0-Unrated 57.58 2/17/2006 32% 1.7 3.5 3.0 RichBKH BLACK HILLS CORP Utilities RS-Rating Suspe2-Neutral 35.60 2/7/2006 23% 1.6 2.1 1.5 RichBLI BIG LOTS INC Consumer Discretionary 0-Unrated 0-Unrated 13.02 2/23/2006 38% 1.3 1.1 1.1 RichBMY BRISTOL-MYERS SQUIBB CO Health Care 3-Underweight 1-Positive 22.10 1/25/2006 25% 2.2 1.9 1.9 RichBSX BOSTON SCIENTIFIC CORP Health Care 1-Overweight 1-Positive 23.34 2/1/2006 36% 1.4 1.3 1.3 RichCAG CONAGRA FOODS INC Consumer Staples 0-Unrated 0-Unrated 20.87 4/13/2006 19% 1.2 1.4 1.1 RichCEY CERTEGY INC Information Technology 1-Overweight 2-Neutral 43.50 1/27/2006 30% 2.0 1.4 1.4 RichDBD DIEBOLD INC Information Technology 0-Unrated 0-Unrated 39.03 1/31/2006 28% 1.1 1.5 1.7 RichEAS ENERGY EAST CORPORATION Utilities 0-Unrated 0-Unrated 24.77 2/10/2006 23% 1.3 2.5 2.0 RichED CONSOLIDATED EDISON INC Utilities 2-Equal weight 3-Negative 46.69 1/26/2006 18% 2.3 1.4 1.3 RichEXC EXELON CORP Utilities 1-Overweight 3-Negative 58.55 1/24/2006 25% 1.8 1.8 1.4 RichFPL FPL GROUP INC Utilities RS-Rating Suspe3-Negative 42.05 1/27/2006 20% 1.0 1.9 1.3 RichHPQ HEWLETT-PACKARD CO Information Technology 1-Overweight 2-Neutral 31.34 2/16/2006 31% 1.5 1.5 1.5 RichISRG INTUITIVE SURGICAL INC Health Care 0-Unrated 0-Unrated 129.58 2/2/2006 64% 1.1 3.4 3.1 RichJP JEFFERSON-PILOT CORP Financials RS-Rating Suspe2-Neutral 56.93 2/6/2006 21% 3.1 2.3 2.1 RichKSE KEYSPAN CORP Utilities 2-Equal weight 2-Neutral 36.50 2/24/2006 17% 1.1 1.4 1.7 RichLEA LEAR CORP Consumer Discretionary 3-Underweight 3-Negative 24.23 1/26/2006 53% 2.6 3.0 2.7 RichMI MARSHALL & ILSLEY CORP Financials 2-Equal weight 2-Neutral 40.99 4/12/2006 20% 2.6 2.5 1.8 RichMRBK MERCANTILE BANKSHARES CORPFinancials 1-Overweight 2-Neutral 56.12 1/24/2006 20% 1.6 1.6 1.5 RichMYG MAYTAG CORP Consumer Discretionary 0-Unrated 0-Unrated 17.43 2/3/2006 55% 1.8 2.2 2.3 RichNYT NEW YORK TIMES CO -CL A Consumer Discretionary 2-Equal weight 3-Negative 27.31 1/24/2006 26% 1.1 2.7 2.3 RichPCL PLUM CREEK TIMBER CO Financials 0-Unrated 0-Unrated 37.86 1/30/2006 22% 2.4 1.4 1.1 RichPGL PEOPLES ENERGY CORP Utilities 2-Equal weight 2-Neutral 36.96 1/27/2006 21% 2.0 1.3 1.2 RichPKG PACKAGING CORP OF AMERICA Materials 0-Unrated 0-Unrated 23.02 4/18/2006 50% 3.0 3.6 3.7 RichSAFC SAFECO CORP Financials 1-Overweight 1-Positive 55.82 1/24/2006 22% 1.5 1.6 1.4 RichSNA SNAP-ON INC Consumer Discretionary 3-Underweight 3-Negative 38.60 2/2/2006 24% 1.4 1.6 2.0 RichSNV SYNOVUS FINANCIAL CORP Financials 3-Underweight 2-Neutral 27.14 4/26/2006 23% 1.1 1.5 1.7 RichSWFT SWIFT TRANSPORTATION CO INCIndustrials 0-Unrated 0-Unrated 22.17 4/25/2006 41% 1.4 1.8 1.9 RichTRB TRIBUNE CO Consumer Discretionary 3-Underweight 3-Negative 29.90 2/1/2006 25% 1.5 1.8 1.6 RichVRTX VERTEX PHARMACEUTICALS INC Health Care 0-Unrated 0-Unrated 33.46 2/7/2006 64% 1.9 2.0 2.0 RichVRX VALEANT PHARMACEUTICALS INTHealth Care 0-Unrated 0-Unrated 18.00 2/24/2006 74% 2.6 3.3 3.2 RichWABC WESTAMERICA BANCORPORATIOFinancials 2-Equal weight 2-Neutral 52.15 4/19/2006 20% 2.4 1.2 1.1 RichWAT WATERS CORP Health Care 2-Equal weight 1-Positive 37.76 1/24/2006 29% 1.3 1.2 1.4 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 8, we provide the current list of stocks having relatively cheap options according to the Lehman Brothers Volatility Screen.Figure 8: 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)ATK ALLIANT TECHSYSTEMS INC Industrials 2-Equal weight 1-Positive 77.26 2/2/2006 18% -1.8 -3.0 -2.8 CheapCMS CMS ENERGY CORP Utilities 2-Equal weight 3-Negative 15.00 2/23/2006 22% -1.9 -1.8 -2.0 CheapCSL CARLISLE COS INC Industrials 0-Unrated 0-Unrated 67.68 2/3/2006 20% -1.5 -1.3 -1.2 CheapFFIV F5 NETWORKS INC Information Technology 1-Overweight 2-Neutral 60.94 4/20/2006 44% -2.1 -2.1 -2.0 CheapGT GOODYEAR TIRE & RUBBER CO Consumer Discretionary 0-Unrated 0-Unrated 17.96 2/21/2006 34% -1.2 -1.3 -1.3 CheapHON HONEYWELL INTERNATIONAL INCIndustrials 2-Equal weight 1-Positive 36.05 1/26/2006 20% -1.8 -2.9 -2.2 CheapHPC HERCULES INC Materials 0-Unrated 0-Unrated 11.14 2/2/2006 28% -1.6 -1.5 -1.5 CheapIGT INTL GAME TECHNOLOGY Consumer Discretionary 0-Unrated 0-Unrated 35.67 4/21/2006 24% -1.1 -1.7 -1.8 CheapKEY KEYCORP Financials 3-Underweight 1-Positive 34.94 4/13/2006 15% -1.4 -1.5 -1.4 CheapLRCX LAM RESEARCH CORP Information Technology 1-Overweight 1-Positive 42.46 4/13/2006 36% -1.1 -1.4 -1.0 CheapOMC OMNICOM GROUP Consumer Discretionary 0-Unrated 0-Unrated 83.06 2/22/2006 18% -1.2 -1.4 -1.6 CheapRTN RAYTHEON COMPANY Industrials 2-Equal weight 1-Positive 40.31 2/2/2006 16% -1.3 -1.5 -1.3 CheapSEIC SEI INVESTMENTS COMPANY Financials 0-Unrated 0-Unrated 38.71 2/3/2006 23% -2.1 -1.4 -1.5 CheapSMTC SEMTECH CORP Information Technology 2-Equal weight 1-Positive 17.91 3/1/2006 37% -2.3 -1.5 -1.2 CheapTE TECO ENERGY INC Utilities 2-Equal weight 3-Negative 17.52 1/31/2006 17% -1.1 -1.4 -1.4 CheapWMI WASTE MANAGEMENT INC Industrials 1-Overweight 2-Neutral 31.27 2/14/2006 17% -1.2 -1.1 -1.0 CheapXEL XCEL ENERGY INC Utilities 2-Equal weight 3-Negative 19.15 2/1/2006 13% -1.3 -3.5 -1.3 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 24, 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 9 and Figure 10, we present this week’s edition of the Earnings Watch.Figure 9: Expected Absolute Stock Price Reactions to Upcoming Earnings Announcements Expected Average Absolute Stock Average Stock Price Move Price Implied 1-day Ticker Name Earnings Price Move Following Following Earnings (1/23/06) Stock Price Move Date Earnings Announcements AnnouncementsAVY AVERY DENNISON CORP 24-Jan-06 57.43 2.6% 4.3% 2.3%BNI BURLINGTON NORTHERN SANTA F 24-Jan-06 71.63 2.8% 1.4% 1.0%CA COMPUTER ASSOCIATES INTL INC 24-Jan-06 28.96 4.4% 3.6% -1.0%CBE COOPER INDUSTRIES LTD-CL A 24-Jan-06 78.69 3.1% 1.8% 0.7%CSX CSX CORP 24-Jan-06 52.38 2.3% 2.6% 1.4%CTX CENTEX CORP 24-Jan-06 73.41 1.9% 2.3% 0.5%CVG CONVERGYS CORP 24-Jan-06 15.55 4.5% 4.4% 0.9%EXC EXELON CORP 24-Jan-06 58.55 3.1% 1.4% 0.5%GDW GOLDEN WEST FINANCIAL CORP 24-Jan-06 68.45 2.2% 1.1% -0.1%GLW CORNING INC 24-Jan-06 23.71 6.4% 7.6% 6.3%JNJ JOHNSON & JOHNSON 24-Jan-06 61.19 1.8% 1.3% 1.3%MCD MCDONALDS CORP 24-Jan-06 35.71 2.4% 1.0% -0.5%NOC NORTHROP GRUMMAN CORP 24-Jan-06 60.76 0.9% 1.3% 0.0%NYT NEW YORK TIMES CO -CL A 24-Jan-06 27.31 3.3% 1.2% -0.6%SUNW SUN MICROSYSTEMS INC 24-Jan-06 4.39 6.2% 4.4% -4.2%ZION ZIONS BANCORPORATION 24-Jan-06 76.05 1.7% 2.2% 1.0%ABC AMERISOURCEBERGEN CORP 25-Jan-06 40.98 1.7% 1.5% 1.0%ABK AMBAC FINANCIAL GROUP INC 25-Jan-06 74.27 2.2% 3.4% -3.0%ABT ABBOTT LABORATORIES 25-Jan-06 40.51 2.1% 1.9% -0.9%ADP AUTOMATIC DATA PROCESSING 25-Jan-06 45.39 1.5% 3.1% 2.7%AHC AMERADA HESS CORP 25-Jan-06 146.00 4.3% 1.8% -0.8%ALTR ALTERA CORPORATION 25-Jan-06 18.44 6.4% 5.6% 2.0%APD AIR PRODUCTS & CHEMICALS INC 25-Jan-06 59.77 1.4% 2.1% 0.1%ASH ASHLAND INC 25-Jan-06 64.28 3.3% 1.6% 0.9%ATI ALLEGHENY TECHNOLOGIES INC 25-Jan-06 41.72 4.4% 5.2% 1.6%BLS BELLSOUTH CORP 25-Jan-06 26.81 1.0% 1.1% 0.5%BMS BEMIS COMPANY 25-Jan-06 28.80 1.6% 2.5% 1.2%BMY BRISTOL-MYERS SQUIBB CO 25-Jan-06 22.10 3.7% 1.9% -1.1%BR BURLINGTON RESOURCES INC 25-Jan-06 91.30 1.1% 1.4% 0.0%CL COLGATE-PALMOLIVE CO 25-Jan-06 53.92 2.1% 2.4% 1.2%COP CONOCOPHILLIPS 25-Jan-06 64.91 1.5% 1.3% -0.5%GD GENERAL DYNAMICS CORP 25-Jan-06 114.63 1.5% 2.1% 0.4%HSY HERSHEY CO/THE 25-Jan-06 53.54 2.4% 2.1% 1.6%IFF INTL FLAVORS & FRAGRANCES 25-Jan-06 34.12 4.3% 2.7% -0.4%KMG KERR-MCGEE CORP 25-Jan-06 103.45 3.8% 1.3% -0.6%LSI LSI LOGIC CORP 25-Jan-06 8.50 8.7% 7.5% -4.9%MHP MCGRAW-HILL COMPANIES INC 25-Jan-06 49.63 2.7% 2.7% 2.0%MKC MCCORMICK & CO-NON VTG SHRS 25-Jan-06 31.25 4.5% 3.2% -2.0%MXIM MAXIM INTEGRATED PRODUCTS 25-Jan-06 39.00 5.3% 4.4% 1.3%NSC NORFOLK SOUTHERN CORP 25-Jan-06 45.45 2.5% 3.2% 0.2%NVLS NOVELLUS SYSTEMS INC 25-Jan-06 27.18 4.8% 6.3% -4.5%PMCS PMC - SIERRA INC 25-Jan-06 9.35 5.1% 7.5% -1.9%PMTC PARAMETRIC TECHNOLOGY CORP 25-Jan-06 6.71 5.5% 5.1% -1.5%PX PRAXAIR INC 25-Jan-06 52.49 1.5% 1.4% 0.1%QCOM QUALCOMM INC 25-Jan-06 46.92 5.8% 5.9% 2.1%ROK ROCKWELL AUTOMATION INC 25-Jan-06 63.97 1.9% 5.5% -0.7%SANM SANMINA-SCI CORP 25-Jan-06 4.48 2.5% 12.0% -0.4%STJ ST JUDE MEDICAL INC 25-Jan-06 53.00 3.9% 3.1% 2.4%SWK STANLEY WORKS/THE 25-Jan-06 51.57 1.8% 4.2% -1.5%WLP WELLPOINT INC 25-Jan-06 71.66 4.1% 4.3% -0.6%XRX XEROX CORP 25-Jan-06 14.40 3.9% 4.7% 0.8%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 24, 2006 5
  6. 6. Equity Derivatives Strategy | Equity Volatility SnapshotFigure 10: Expected Absolute Stock Price Reactions to Upcoming Earnings Announcements (contd.) Expected Average Absolute Stock Average Stock Price Move Price Implied 1-day Ticker Name Earnings Price Move Following Following Earnings (1/23/06) Stock Price Move Date Earnings Announcements AnnouncementsACV ALBERTO-CULVER CO 26-Jan-06 43.87 2.6% 4.1% 3.4%AMGN AMGEN INC 26-Jan-06 74.90 3.6% 4.2% 0.1%ANDW ANDREW CORP 26-Jan-06 11.21 4.0% 9.6% -3.6%BAX BAXTER INTERNATIONAL INC. 26-Jan-06 38.39 2.9% 2.1% -0.2%BC BRUNSWICK CORP 26-Jan-06 40.20 2.1% 4.5% 0.6%BDX BECTON DICKINSON & CO 26-Jan-06 59.21 1.8% 3.2% 2.8%BEN FRANKLIN RESOURCES INC 26-Jan-06 97.29 1.5% 1.3% 1.0%BLL BALL CORP 26-Jan-06 40.59 2.3% 2.5% 0.9%BRCM BROADCOM CORP-CL A 26-Jan-06 56.88 6.5% 5.6% -0.9%CAH CARDINAL HEALTH INC 26-Jan-06 69.45 2.9% 4.3% 3.3%CAT CATERPILLAR INC 26-Jan-06 61.04 3.5% 4.5% -2.7%COL ROCKWELL COLLINS INC. 26-Jan-06 43.80 3.4% 2.2% 1.6%CPWR COMPUWARE CORP 26-Jan-06 8.37 4.1% 8.5% 5.9%DGX QUEST DIAGNOSTICS 26-Jan-06 49.00 3.2% 2.8% 2.1%DHR DANAHER CORP 26-Jan-06 54.35 2.2% 2.0% 0.6%DJ DOW JONES & CO INC 26-Jan-06 37.88 2.9% 2.5% -2.5%DOV DOVER CORP 26-Jan-06 43.31 1.6% 2.9% -0.5%DOW DOW CHEMICAL 26-Jan-06 42.43 3.3% 1.4% 0.0%EMN EASTMAN CHEMICAL COMPANY 26-Jan-06 51.28 2.2% 4.1% 2.8%FDC FIRST DATA CORP 26-Jan-06 42.34 3.3% 2.5% -0.4%GWW WW GRAINGER INC 26-Jan-06 73.30 2.5% 3.9% 2.0%HIG HARTFORD FINANCIAL SVCS GRP 26-Jan-06 85.54 0.4% 3.4% 1.3%HON HONEYWELL INTERNATIONAL INC 26-Jan-06 36.05 2.4% 2.4% -1.0%JNS JANUS CAPITAL GROUP INC 26-Jan-06 21.19 4.0% 3.8% 0.4%KLAC KLA-TENCOR CORPORATION 26-Jan-06 51.77 4.1% 3.7% 0.1%LEG LEGGETT & PLATT INC 26-Jan-06 23.30 1.7% 4.6% 2.0%LLY ELI LILLY & CO 26-Jan-06 57.21 2.3% 1.8% -0.2%LMT LOCKHEED MARTIN CORP 26-Jan-06 65.40 1.6% 1.5% 0.4%MCK MCKESSON CORP 26-Jan-06 49.94 3.9% 4.7% 2.8%MIL MILLIPORE CORP 26-Jan-06 65.00 2.5% 5.9% 1.3%MRO MARATHON OIL CORP 26-Jan-06 72.55 3.6% 2.2% -1.0%MSFT MICROSOFT CORP 26-Jan-06 26.35 2.6% 2.9% 0.6%MWV MEADWESTVACO CORP 26-Jan-06 26.90 0.8% 0.8% 0.6%NCR NCR CORPORATION 26-Jan-06 37.25 3.1% 2.1% -1.5%NE NOBLE CORP 26-Jan-06 84.30 2.8% 1.7% 0.6%NWL NEWELL RUBBERMAID INC 26-Jan-06 23.99 1.2% 4.6% 1.7%PKI PERKINELMER INC 26-Jan-06 22.95 2.6% 4.4% 1.5%RHI ROBERT HALF INTL INC 26-Jan-06 36.58 4.9% 8.2% 4.5%SHW SHERWIN-WILLIAMS CO/THE 26-Jan-06 48.70 2.6% 2.7% -1.3%SO SOUTHERN CO 26-Jan-06 35.23 0.9% 1.2% -0.3%SYK STRYKER CORP 26-Jan-06 45.00 2.8% 6.1% -2.3%T AT&T INC 26-Jan-06 24.45 2.2% 1.4% -0.1%TLAB TELLABS INC 26-Jan-06 10.95 6.2% 6.0% 1.1%TXT TEXTRON INC 26-Jan-06 75.76 1.9% 3.4% 2.3%UIS UNISYS CORP 26-Jan-06 6.18 10.3% 3.8% -3.8%UPS UNITED PARCEL SERVICE-CL B 26-Jan-06 75.21 2.1% 1.5% 0.7%UST UST INC 26-Jan-06 41.10 0.8% 4.1% -0.7%VZ VERIZON COMMUNICATIONS INC 26-Jan-06 31.00 1.9% 1.4% 0.8%ABI APPLIED BIOSYSTEMS GROUP-AP 27-Jan-06 27.53 3.8% 4.0% 3.8%BDK BLACK & DECKER CORP 27-Jan-06 84.56 2.3% 3.3% -0.2%BOL BAUSCH & LOMB INC 27-Jan-06 70.29 4.3% 2.9% 1.0%CVX CHEVRON CORP 27-Jan-06 62.21 1.0% 1.1% 0.3%D DOMINION RESOURCES INC/VA 27-Jan-06 78.13 1.9% 1.1% -0.7%GCI GANNETT CO 27-Jan-06 62.86 1.1% 0.9% -0.1%GDT GUIDANT CORP 27-Jan-06 76.00 1.9% 1.5% -0.8%HAL HALLIBURTON CO 27-Jan-06 77.01 4.4% 3.7% 0.6%HCR MANOR CARE INC 27-Jan-06 39.25 0.9% 2.6% 1.3%ITT ITT INDUSTRIES INC 27-Jan-06 105.67 2.7% 3.4% 0.8%NUE NUCOR CORP 27-Jan-06 72.40 1.5% 2.3% 1.7%PG PROCTER & GAMBLE CO 27-Jan-06 57.64 1.4% 1.3% -0.5%PGL PEOPLES ENERGY CORP 27-Jan-06 36.96 2.3% 1.6% -0.9%RBK REEBOK INTERNATIONAL LTD 27-Jan-06 58.86 0.1% 4.1% 0.5%TROW T ROWE PRICE GROUP INC 27-Jan-06 76.18 2.0% 1.8% 1.3%AFL AFLAC INC 30-Jan-06 47.16 1.8% 4.3% 1.1%CMI CUMMINS INC 30-Jan-06 93.40 2.9% 3.5% 1.0%EK EASTMAN KODAK CO 30-Jan-06 24.41 2.2% 6.3% -0.1%FISV FISERV INC 30-Jan-06 43.77 1.7% 5.5% -0.4%MAT MATTEL INC 30-Jan-06 14.89 0.9% 4.2% -1.0%SEE SEALED AIR CORP 30-Jan-06 55.03 2.9% 2.8% 1.4%SGP SCHERING-PLOUGH CORP 30-Jan-06 19.71 2.2% 1.5% 1.3%SYY SYSCO CORP 30-Jan-06 30.40 1.6% 2.4% 0.1%UNM UNUMPROVIDENT CORP 30-Jan-06 22.28 2.5% 5.1% 1.9%XOM EXXON MOBIL CORP 30-Jan-06 61.20 2.0% 1.5% -0.8%ZMH ZIMMER HOLDINGS INC 30-Jan-06 69.00 2.4% 3.4% 0.8%Source: 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 24, 2006 6
  7. 7. 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 24, 2006 7
  8. 8. 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 24, 2006 8
  9. 9. Equity Derivatives Strategy | Equity Volatility SnapshotDistribution of Ratings:Lehman Brothers Equity Research has 1835 companies under coverage.42% have been assigned a 1-Overweight rating which, for purposes of mandatory disclosures, is classified as a Buy rating, 36% 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, 74% 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. 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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 24, 2006 9

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