There is an interesting Bloomberg article today giving a postmortem on the Bear Stearns stock decline. In particular, the purchase of deep out-of-the-money puts are investigated. As quoted in the article, "On CSI Wall Street, the options are the DNA." As it turn out, trade data shows that 5.7 million puts traded on March 11 of this year at the $30 strike price, along with 1,649 that traded at $25, worth in total about $1.7 million. The kicker, and why this is raising eyebrows, is that when purchased these puts were over 50% below the March 11 closing price of $62.97, and also only had about a week and a half until expiration. As far as the investigators are concerned, the traders either were buying a lottery ticket, knew something was going to happen, or were in the process of making something happen. Rumors of insolvency and investor concern filled the airwaves for the rest of the week putting further pressure on the stock until it was trading around $30 by the end of trading on Friday the 14th. On that same day, with the stock opening around $54.24, the CBOE starting listing eight new put option contracts with strikes going down from $22.50 to $5, each with an expiration of only one week. That same evening Treasury Secretary Paulson called CEO Schwartz stressing the need to find a buyer to avoid the appearance of a Government bailout. And as they say, the rest is history. Even more suspect is that on Friday March 14, a total of 6,303 of the $5 strike puts traded, above the $2 initial purchase price, but well below the Friday closing price. I am sure those individuals have been receiving some calls, as well as making a few call themselves.

Reuters reports that while the failure of Bear Stearns would have likely triggered a series of counterparty failures in the credit default swaps market had the Fed not come to the rescue, CDS securities have actually held up pretty well and remained relatively liquid even while other financial markets have had their challenges. To date, since the market for credit derivatives has come into being, there has not been a default from a major dealer or bank. Ironically, the Bear Stearns issues themselves may have helped bolster the CDS market since not only did the Fed prevent potential counterparty failures associated with Bear, but they also gave the impressions that other major derivative counterparties were too big to fail.

Other markets have not fared as well. Recent credit problems and housing related losses have reduced the flow of capital in the mortgage-backed security, CDO, auction-rate security, corporate bond, and preferred shares markets. On the other hand, liquidity in the CDS market, especially for 5-year duration securities, has been better than other markets, even though it too has experience less dealers, lower liquidity, and wider bid-ask spreads than normal. Yet, it is still functioning and allowing investors with illiquid corporate bond exposure to buy protection with credit derivatives.

Of interest for traders is that in some instances CDS securities have weakened ahead of stock prices, giving traders some clue as to what equities are a cause for concern. As an example, the CDS spreads for Bear Stearns widened by 10 times over two months last summer, significantly under-performing the stock and giving some insight into potential problems. Shortly near the end of the two month period, two Bear Stearns hedge funds collapsed from bad mortgage bets. The traders that were focused on credit risk hedged their exposure in the CDS market long before problems became evident to the equity market. Something worth noting as we hear of new activity in the credit derivative markets going forward.

Based on recent filings, and acquiring 95 million shares of Bear Stearns, JPMorgan Chase should own a little less than 108 million shares, or 44.86% of Bear shares outstanding. Additional planned buying should raise the common stock total to 49.5%. Yet, BSC stock still trades above $10 per share. Maybe it is time to check the option's market.

Tickers: JPM, BSC

It looks like former CEO and current Bear Stearns chairman Jimmy Cayne and his wife sold their 5.66 million share stake in Bear (for $10.84 per share). His stake was about 3.9% before JPMorgan offered a new price and got new terms (a 39.5% stake in Bear, reducing the Cayne's position to 2.4%). From the filing it appears to be a block sale. In that case, who now owns the position? Beyond making a new bid look unlikely, does this affect the sale? The previous board had indicated that it intended to vote their shares for the merger. Does JPMorgan need this 2.4%? Did the shares go to JPMorgan? The drama continues ....... and the prices still trades above $10.

Ticker: BSC, JPM