Conoco Phillips (COP, news, chart, volatility) appears to have been the subject of a substantial collar strategy Tuesday. Shares gained $3.94 to $73.25 after crude oil rose 5 percent and reclaimed $100 a barrel. The top two trades in COP options included 7,500 of the January 2010 puts with the 50 strike and 7,500 of the January 2010 calls with the 120 strike price. While the calls traded bidside for $2.00, the puts hit on the offer for $3.65. Both traded on the AMEX at 15:11.

Within minutes of the options trades, a block of almost 200,000 COP shares traded at $72.85 on the PHLX. Taken together, the action appears to be part of a substantial collar. If so, the strategist owns shares, bought the 50 puts for downside protection, and sold calls to help finance the purchase of the puts. The cost basis for the stock is $74.50 (stock price + put – call), with the put keeping a floor under possible losses below $50 (32.9 percent) and upside profit potential to the strike price of the call, or $120.00 a share (61 percent).

Alpha Natural Resources (ANR, news, chart, volatility) saw bullish trading amid a recovery in the coal stocks Tuesday. The Market Vectors Coal Fund (KOL), which was down 40 percent month-to-date prior to today, gained $2.25 to $29.44. ANR was one of the stars of the show, rallying $8.02, or 18.5 percent, to $51.43. In the options market,13,000 ANR calls and only 634 puts traded on the day. The volume included a block of 5,000 January 65 calls traded offerside for $5.50 and 5,000 of the January 85 calls traded bidside for $1.10. With open interest of 273 in the 65s and 781 in the 85s, the volume appears to be the opening of a substantial bull call spread. If so, the strategist bought the 65s, sold the 85s, and paid a net debit of $4.40 per spread. The potential payoff is $15.60 if ANR rallies above $85.00, or 64.6 percent, by January options expiration (108 days).

30,000 of the October 40 Puts traded late this afternoon, priced at $17.60 or 15cents above parity based on the stock price of $22.55. This type of volume (also seen in deep puts on CEG today) involves a strategy to avoid being assigned on short positions that have no remaining time value and are likely to be assigned in the overnight clearing process. In this case there are 7494 open contracts in the AA Oct 40 puts. If most of the long put holders exercise tonight, the traders with short positions can expect to be assigned on a pro-rata portion of their position. The remaining unassigned position will yield a small profit. For example, if 75% of the puts get assigned, and two market makers happened to be short 3000 contracts each, they could expect to be assigned on 75% of their positions, or 2250 contracts. The non-assigned 750 contracts is a small amount of extra profit to their portfolio.

This afternoon’s volume of 30,000 contracts is actually two market makers each buying 15,000 from each other and then immediately exercising the long position (without letting it close the short on their books). Their trades grow the total OI to 37,494 contracts with a total of 35,620 exercised instead of 5620. While they will still be assigned, the ratio of contracts exercised to their short position has changed, and that is the key to this arbitrage. Instead of a 75% exercise ratio, now 95% of the open interest will be assigned. Each market maker can expect to see 95% of their 18000 short contracts assigned, but this 17,100 contract assignment will be netted against their own exercise of 15,000, resulting in a final net assignment of 2100 contracts each, instead of 2250 (or 70% of their short). If the gain from non-assignment is 5cents per contract, this works out to risk-free profit of $747.12 for each market-maker.

Who loses that money? The participant who was short the remaining 1494 contracts and unable to execute the same trade. If that trader runs the numbers he or she will find they were assigned on 95% of their position, even though only 75% of the incoming open interest was exercised. The strategy works on deep calls prior to ex-dividend date in the same way.

Post Script 10/1/08 OCC data shows that only 35% of the original open interest were exercised- changing the net effect to $1942 of profit per market maker.

Caterpillar (CAT, news, chart, volatility) is bucking the bullish trend Friday. It is the only stock among the Dow thirty not moving higher late Tuesday. CAT is down 72 cents to $59.17. In the options market, trading is active. 25,000 CAT puts and 15,000 calls have traded. Most of the put volume is in the October contracts with strike prices ranging from 50 to 62.5. According to an exchange floor contact, an investor sold 3,750 of the October 62.5/57.5 spreads and bought the same number of October 55/50 put spreads. In this case, the strategist might be banking profits in one spread after the 16.3 percent decline in shares of Caterpillar in September and also looking for additional weakness in the stock from now until October options expiration.

Allied Capital (ALD, news, chart, volatility) implied volatility is reaching 225 percent, up from under 80 percent yesterday, on news lender Ciena Capital, one of Allied’s portfolio company’s, filed for bankruptcy. The credit cruch has caused the value of Ciena’s assets to decline and the company cannot repay its debt. Allied guarantees Ciena’s obligations and will pay $320 million to the lenders behind the facility. Shares of Allied tanked on the news, hitting a low of $5.50 midday before bouncing back to $8.25. Shares are down $4.30, or 34.3 percent. In the options market, volume in ALD is running 17 times the usual. 6,200 puts and 2,500 calls have traded. The October 7.5 puts are the most actives, with 1,790 traded. Implied volatility is reaching all-time highs, reflecting heightened volatility expectations for shares of Allied Capital.

Duke Energy (DUK, news, chart, volatility) is seeing bearish order flow Tuesday. Shares are trading down a nickel to $17.56 after the utility company said it was drawing roughly $1 billion from a $3.2 billion credit agreement. CFO David Hauser says, “In light of the uncertain market environment, we made this proactive financial decision to increase our liquidity and cash position and bridge our access to the debt capital markets.” The news appears to have stirred up a bit of bearish trading in DUK options. 6,200 puts have traded so far today, compared to just 343 puts. The October 17.5 puts are the most actives. 3,100 contracts traded. November 15 and 17.5 puts are also active and directional sentiment based on total options order flow in Duke is 65 percent bearish.

Fifth Third Bancorp (FITB, news, chart, volatility) shares are up 34% today, trading near $12.21 on optimism regarding recovery. Option volume is running near 5 times normal, with 51,000 contracts trading and nearly 90% of the volume involving puts. 61% of the activity tool place on the ISE and consists of vertical put spreads. Early in the day a seller unloaded nearly 4000 deep January 17.5 – 15 put spreads for a credit of $1.45, likely realizing a gain from a buy last week for 1.40 when the stock was above $16. Just 15 minutes later a buyer (likely the same customer) began buying Jan 5-7.5 Put spreads for 1.12. This account appears to be rolling down to profit (or hedge a long stock book) in the case of another downside wave.

Atheros Communications (ATHR, news, chart, volatility) calls are active. Shares of the Santa Clara, California semiconductor company are up 91 cents to $23.06 after Collins Stewart resumed coverage on the stock with a Buy rating and a $28 price target. The firm says the target market for Atheros’ products is growing and the company can grow even if market share stays the same. Bullish trading is being seen in the options market. Total options volume is running three times the usual. 14,000 contracts have traded, compared to 792 puts. The October and November 22.5 and 25 calls are seeing action, with about 55 percent of today’s volume trading offerside.

Harley Davidson (HOG, news, chart, volatility) is seeing three times normal options trading volume. Shares of the motorcycle company are riding southward, down $1.76 to $36.17, despite big gains for the broader market. There is no news on the stock today. Sentiment in the options market is bearish as well. 20,000 puts and 11,000 calls have traded on HOG. The February 45 calls, February 37.5 puts and February 30 puts are the day’s most actives. According to one exchange floor contact, the volume in those contracts was tied to a customer order, which involved buying 5,000 of the February 37.5/30 put spreads and selling 5,000 February 45 calls for a net debit of $1.15. If so, the strategist is clearly bearish and stands to gain $6.35 (x 100 x 5000) should Harley continue its run lower and make a move below $30 a share between now and February options expiration.

The Currency Shares Euro Trust (FXE, news, chart, volatility) is down $3.57 to $141.08 after the euro fell “the most against the dollar since the introduction of the shared currency in 1999 as France and Belgium led a state-backed rescue of Dexia SA, the world’s biggest lender to local governments,” according to Bloomberg. The fund, which tracks the euro/dollar currency pair (x 100), is down 5.3 percent since last Monday. Today, 2,900 FXE puts and 1,300 calls have traded. Implied volatility is up 2 points to 17 and moving to record highs.