Lehman Brothers Pitches War And Peace Trade

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Lehman Brothers Pitches War And Peace Trade

The declaration of a war on terrorism and subsequent attacks on Afghanistan by the U.S. has prompted Lehman Brothers to recommend clients sell volatility on a basket of stocks it dubs "war" securities versus a basket of "peace" stocks. Implied volatilities for the stocks in the war basket have increased despite a decline in realized volatilities because there has been a perceived increase in systematic risk, said Paul Lieberman, v.p. of equity derivatives and quantitative research in New York.

In the trade clients sell out-of-the-money calls and puts with maturities of three to six months on the underlying stocks in the war basket. "That way the investor can capture some of the richness on the implied volatility," Lieberman said. If, however, the investor believes stocks in the war basket will rally, Lehman recommends investors put on a directional trade and buy calls. The trading concept is aimed at institutional investors.

The perceived increase in implied vol is unwarranted because event risk as a result of the war on terrorism has had little or no impact on the realized volatility of the war basket, according to Lieberman. The peace trading basket shows the normalized performance of each basket and the spread between the two. For example when there are either reports of or incidents of terrorism, the spread between the two baskets tends to widen. When the market gains confidence the spread tends to diminish, he explained.

The war basket includes names such as AT&T Wireless, Immunex Corp., JDS Uniphase and Lucent Technologies. The peace basket includes Dana Corp., Carnival Corp., Tiffany & Co. andGoodyear Tire & Rubber Co.

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