Morning Update

Yesterday shares of Morgan Stanley closed down 6.6%, leading the broader market down as fears of a hung Italian parliament looked like an increasingly likely scenario. Morgan Stanley was one of the hardest hit stocks in the S&P 500 because of its exposure to European peripheral bonds. The stock saw extremely high option volume yesterday, with 9.5 puts trading for every call. One of the biggest trades of the day was the purchase of 20,700 Oct. 23 puts and sale of an equal number of Oct.18 puts. The trader paid a net debit of $1.79 for this put spread, which was put on when the stock was trading 22.75.

Time has shown that when the market is spooked over Europe, Morgan Stanley is one of the first stocks to be sold. This is because the company is seen as the weakest of the “too big to fail” banks. Last year the bank made a lot of progress and posted earnings of $1.59 a shares versus a net loss in 2011. Revenues also increased to $30.514 billion in 2012 from $28.555 billion in 2011. But traders yesterday sold the stock and made bearish bets on the stock because Morgan Stanley has $6.3 billion of total exposure to European peripherals, with Italy accounting for $3.2 billion of that. This sum should be able to be absorbed by Morgan Stanley in the worst case scenario, but that did not seem to matter in yesterday’s emotional trading session.

This put spread is a bet that Morgan Stanley will continue to sell off over the coming months. The spread will reach its maximum profit if Morgan Stanley is at or below 18.00. In this case the spread will worth $5.00 and the risk is limited in the trade to the $1.79 paid upfront for the options. This gives the spread an excellent risk/reward profile and makes it an interesting portfolio hedge trade since Morgan Stanley is likely to see more downside if fears over Europe continue to grow. The