welcome to "options action." here's where the action is tonight. earnings shocker, which one of these companies says the market could rally? piecing together a merger. sizzle index. >> this is one of the chicken or eggs, which came first? call activity that led to the market speculation. >> now stacey and dan duke it out on how to play a potential deal. who will prevail? the upside call. how to play the return of steve jobs. >> i think the investment community is comfortable with the fact that this guy may not be there. >> the smart money setup ahead of the earnings options. "options action" begins now.

these are the "options action" traders on the desk and across the nation in chicago, the windy city and in the city of brotherly love, of course, talking about philadelphia. stocks breaking a four-week losing streak to pose their best five-day move since march. a bevy of earnings from intel and ibm lifting tech and the broader markets on a busy friday but another crucial test is days away when the biggest week for earnings gets under way, so how is the smart money setting up? time to get "in the money." this week was the earnings quiz. the next week is certainly the finals. real fun beginning tuesday when apple and yahoo! report, but traders will digest earnings from wells fargo, microsoft, amazon.com and american express. volatility, which had spiked heading into this week's clash of earnings, actually fell over the last couple of days. does that mean traders are getting more confident when it comes to earnings season? >> i don't know necessarily they're getting more confident. this week it caught me a little bit by surprise, i have to say. kind of expected what we saw,

nevertheless i thought it was going to have less of an impact on the market. certainly ibm, that was really a good forecast there and helped drive us higher. goldman sachs and stuff we were seeing earlier last week and so on, these things, why they're driving the market, i'm not 100% to be sure, to tell you the truth. but a lot of stuff is coming up next week. a better barometer for the economy than the things we've seen. >> even though the bullish forecast, even though it drove the entire sector higher, that's reading too much into it? >> it could be. the tech stuff was great, but by all accounts and outlooks were great and could be specific to the businesses of intel and ibm, early cycle place. as it relates to the financials, you know, there's one constant i took out of all these earnings, and they were pretty good and kept the gains in the stocks, but one constant was the idea of loan charge-offs. heard it from j.p. morgan and bank of america and citigroup and got a number from american

express, their june charge-off was 10%. this is something i think sets the stage for the second half of the year. if there is another leg down in the economy, and put it together with the unemployment data in june -- >> i got to jump in. pretty good based on much lowered expectations. >> right, fine. >> since july 8th, 38 of the s&p 500 companies have reported, and the average is about a 16% beat which on a standalone basis in the normal market we would probably say is phenomenal. i would have to say, based on the lower expectations here, very low hurdles here, i can't get as excited. >> one thing points financials to wrap it up, we have a couple things next week we'll keep a close eye on, wells fargo and american express. more consumer oriented than goldman sachs, so something we have to keep a close eye on. that will set the stage for the next leg down in the economy if it comes to play. >> scott, out to you. don't want to monopolize the conversation here at the desk in new york city.

you're saying that it's more of a stock picker's market right now. >> we've seen some anecdotal option buying in a number of names. saw it in yahoo!, broadcom and xlp, consumer staple etf earlier this week, but the interesting thing, even though people planted their flag in the ground, and bought options, some puts and some calls, it didn't slow down volatility coming in. the vix has come down despite the fact we have important names to report, so i think that tells us as much as we need to know about options, people are much more comfortable. they're happy selling options despite the anecdotal buying that we've seen, obviously more sellers because volatility has come in substantially. >> stacey, what's your feeling on the whole big move we saw this past week, 7% across the indices? >> it feels like if you look at the way people are positioning the options, it feels similar to what we've seen over the last couple of weeks, we saw some --

one of the differences is people were buying back some of those calls and rolling them out. brocade, saw them buying those back their july 5 calls and that was amidst takeover chatter. one thing i would stress about this week, what it really felt like, people were talking about did you see intel? did you see ibm? did you see, you know, goldman sachs, and you'd say did you see nokia? no, but you're not listening to me. did you see intel? people saw what they wanted to see, and another thing i would stress to scott's point, the volatility coming in during earnings season, first two weeks are most important, volatility tends to come out of everything after that, so we've gotten one of the big weeks behind us. next week is interesting but not surprised to see those coming back in. >> see if we can throw up the calendar. certainly a big one. what is the one stock, dan, why don't you kick it off that you are watching? >> apple will be one. it's kind of like goldman sachs, the outlier, but will give us a good sense for what high-end retail, you know, looks like

because we don't actually see retail coming until about early august. a lot of the retailers don't report until then. i think that's very, very important. i don't think they're going to actually -- i don't think the market will trade off guidance, per se, we know they give cautious guidance in general. >> scott? >> i think american express is much more important. it really is the entire economy capsulated into one name. apple not so much. the believers in apple are the believers in apple like the people who think we didn't go to the moon. no matter what we say to them, they won't change their mind. we have one in dan. he is an absolute believer in apple. i don't know what we would say to change his mind or should we want to change his mind. >> right. okay, axp, one scott is watching. you're watching it, as well. at the cross section of the consumer as well as financial world. >> yeah, absolutely. one of the things we've been talking about, a lot are these stock specific situations looking at or better a barometer for the broad economy? i feel like american express is falling into that latter camp.

this is a company that, you know, obviously it doesn't have the greatest view from the people on the street. jpmorgan did raise it but to a $25 price target and trades at a high multiple. three sequential quarterly declines, 4%, 8% and 11.8%. what this -- what the revenue picture in american express is telling us in particular is a lot about what consumers are actually doing. the quantity of transactions they're doing and the quality of those transactions. how much money is actually being spent? the company is doing a great job managing its earnings in a negative situation, and one of the things we really ought to take a look on the revenue side, the bearish bet that we saw was the collar trade in october, the 25/30 that traded 5,000 times. someone bought the 25 put and sold the 20 calls. might have been doing it against a long stock position or outright as a bearish trade. i like the position in terms of

its bearish tenor, but don't necessarily like -- >> what's your trade? >> i would use the same strikes and buy the august 30, 25 put spread and the max i can make in profits is $2.80 and the standstill return, if the stock does nothing, i'll lose 20 cents to make the bet. i want to cap my potential losses in case i turn out to be dead wrong, like i was in ibm this week. >> what do you make of it? >> i like both. the thesis, the trade. what i think is important is intel has shown us anything, it's just the market can really go against you, so you really want to have that protection on. >> absolutely. okay, moving on to the next option here for american express, set the tone for financials. microsoft is sure to move the needle. on technology. the giant has had a massive move since it jumped from 25%, but what does the options market see for earnings? so let's go into the zone right now. current option prices are

implying a 3.5% move on earnings, slightly less than 4, so you correctly called the rally in may, buying the 17 strike call for 2 bucks. that went out at about 7 bucks. what are you seeing this time around? >> if you didn't change anything or own those calls or don't own those calls, microsoft, that move is pretty low. one of the things i would look to, what did we hear, comments from intel which suggested the pc market was doing well, but then you had dell comments that suggested the complete opposite. my concern is what can microsoft really say after this current rally? can they boost guidance the same as ibm did? probably not. given their upcoming product launches. i think it looks attractive. more nervous with microsoft on the downside. one of the strategies that is attractive is buying the august 24 puts, at 90 cents. if i'm wrong, which, you know, unfortunately i occasionally can be, if i'm wrong, one of the things that's interesting, as you said, not a huge implied move being priced in.

if microsoft drifts higher or doesn't move, you will be able to still collect -- you'll lose a little bit of premium but not a ton of premium from what you paid for it. >> scott, you're also bearish on microsoft and concerned about possible delays to windows 7, but do you like the trade that stacey has on? >> i do. volatility on microsoft has come down from the mid-30s to low 30s so puts are on sale. if stacey is outright buying a put, you know it's on sale. >> wow. >> cheap, i said it. >> i'll jump in there and say you know, i think the thesis is 100% correct. i don't think the company has a whole heck of a lot to gain to give a bullish outlook into the potential delays for this windows 7 product. that said, i know the puts are cheap. i'd sell at 20 or 21 points in august to lower the cost that have bearish bets. it's really not going to $20.

>> it's 97 -- >> those are cheap options too. the option she's recommending buying is a cheap one. why would i bother to finance it by selling a cheaper one, something i usually don't like doing, so i'd stick with just buying the one. >> time to move on -- ♪ why can't we be friends >> that is a song i haven't heard in a while. the soulful sounds of war with their classic "why can't we be friends," i'm either in an elevator or doing a thesis, put up or shut up. they duke it out over strategy. it can get heated, hence the call for friendship. tonight dan takes on stacey who, by the way, has ruled against him in his last three bouts with mike. tonight we kick it off with a name that is a virtual options obsession, talking about mosaic. extremely active on takeover talk. stock was up sharply today, but then reversed after it acquired -- rumor acquired put

the kibosh on any takeover talk. it sent shares lower, but stacey and dan remain bearish on the name. kick it off, stacey. >> one of the things coming up for mosaic is earnings. something i'm definitely concerned about. if i were comfortable being short a stock, i would say let's sell it here. luckily options exist and we don't have to do such a thing. what i'm looking at is for a bearish strategy, one heading into earnings. two, upcoming contract negotiations with india and china. both likely to end up by the august expiration. i think i'm concerned that those pricing levels won't come into a level that is positive for mosaic. people aren't buying their product, so, three, the one thing i'm concerned about, takeover rumors that you talked about, yes, the company did come out late today and say, no, no, no, we're really not interested in buying mosaic. okay, that doesn't mean that they won't. so i'm really concerned about being short that stock outright. a couple of things i did not want to do. i didn't want to be net short options. volatility looks pretty cheap in mosaic. i didn't want to find myself

being short more options than i'm long. >> what are you doing? >> last point, the other thing i'm not comfortable is calling a bottom. i don't know where it would bottom out if it falls. the strategy i like selling the august 45, 55 call spread. toward the end of the day it came in a little bit. you could expect $4.20. rewarded before 20. risk, $5.80. you have those upcoming events. if i'm wrong at any point, at least you're stopped out. >> dan?. >> i think you're risking too much to make something that doesn't have a huge probability of really happening, and so, you know, i agree with stacey's fundamental view, and one of the things i want to do, a trade i suggest often, one by two put spread. in august, i want to buy the 50/45 and pay 20 cents for that. if they're bought out and wake up monday and there's a $70 bid on the table, i lose 20 cents. worst case scenario. if it goes below 40, that's a level where it's bottomed out

about a half a dozen times over the last six months. i feel comfortable owning it there, and the flip side is, you know, i don't think risking 450 or whatever stacey is risking, the chance they get bought out i don't think that is a proper risk/reward there. >> i agree with basically everything both of you have said, i have to say. >> what are you, judge judy? >> i have to go with dan on this one. the reason i'm going to go with dan despite stacey ruling in my favor for a couple of trades in a row basically comes down to two things. one, you do need to draw a line in the sand about what you think is going to be the worst case in every trade you take a look at. and i think where he's drawing a line in the sand at the $40 level on the downside is good. the other thing is he's risking 20 cents. if there is a takeover, that's all i'm going to be risking and i like that. >> is victory sweet, dan? >> finally. >> okay, first time. first time. >> okay, got a question, send us an e-mail,

optionsaction@cnbc.com. coming up next, "hot hand with apple. but can it continue through earnings? stick around and find out. time for "pump up the volume," the names heating up options traders' sizzle index this week. founded in 1760s, the first american tobacco company is the nation's third largest maker of nicotine products but brands including newport, maverick and old gold. shares were ignited after call volume was smoking off the charts. who is it? the answer when "options action" returns.

reynolds may make a bid for them. i think the actual speculation makes perfect sense. the timing, probably a year away. >> time for "the upside call" and look to manage some of our more successful trades. anyone who followed his other tech picks know that he's the apple of our eye.

♪ >> on "options action," we're always looking to risk less and possibly make more. case in point, didn't risk reversal on apple. >> i'm going to buy the august 125/150 risk reversal. >> when traders buy a risk reversal, they're making a bullish bet on a stock by selling one out of the money put to reduce the cost of buying one out of the money call. the goal, to profit from a sharp move higher in the stock. a trade-off, if the stock falls below that put you sold, you're obligated to buy the stock at the strike price. in the case of dan's trade, he sold the august apple 125 put for $2.40 and used that money to buy the 150 strike call for $4.70. all told, he spent a total of $2.30, the difference between the cost of the call he bought and the put that he sold. if apple falls below that 125

strike put that he sold, he would be forced to buy apple shares for $125. >> if there was ever a company in the s&p you would want to put a buy limit below the market, it's probably these guys. >> if apple shares rally, that 150 strike call he bought becomes more valuable. >> 20% of their market cap has been cashed. they have no debt and in a massive product cycle. >> since the time of his trade, apple shares have rallied some 5% increasing the value of the call that he bought and decreasing the value of the put that he sold. but could this man ruin dan's good trade? >> if there was a negative headline, we think it would be down 5% given investors are expecting him to be back in some capacity. >> two men find themselves unlikely partners, united by a common goal, making sure apple stays on top. and with earnings just days away, "options action" fans of

all walks are glued to their tvs, all asking the same question, what will dan do now? >> i love it. >> let's not keep the dalai lama or paris waiting any longer. >> now, that we're attached at the hip, call me. what i want to do here, it's simple here. i want to reduce the risk and the risk reversal. i want to take in that 125 put in august that i sold for 240 and cover it for 70 cents. i'm going to lock it in $1.60 profit. then i own that august 150 call. it's worth $5 more than what i bought it for if you incorporate the profit i made in the put. now i want to turn that 150 call into a 150, 160 call spread in august and essentially selling the august 160 call for $3.50. i'm locking in a $5 gain. that's basically 200% of the premium that you put up for this trade. i have no risk into earnings. essentially, my thesis hasn't changed. i think the stock has more to go.

>> you're absolutely killing me. the reason you're killing me is because the first trade was so good, first of all. i loved everything about it. it was a great call on the stock and i thought it was a great trade. what i don't like is what you're doing now though. i mean, would you actually run out in a vacuum, would you run out and buy that. >> i actually have it on for free. >> no, sell the 150, close out the put and buy the 160. >> okay. you be the arbiter. what would paris hilton say about dan's trade? that's hot? >> all being fair, dan, great call on the first time around. this isn't personal. i have to agree with mike. i don't like rolling it into this call spread. i would take my profits and be happy. >> scott, quickly? do you side with paris or mike? >> i actually think this is a really great way, it's a creative way to spin into a new trade. i'm going to go with the guy who's got the hot hand. >> all right. got a question, send us an e-mail. we'll answer it during your web

extra. i do read every e-mail we get. go to our website, your chance to ask a question and our chance to educate you. that is right after the show.

we've got big news coming out of the world of options. a newly listed option. tom henry coe born today, eight pounds, six ounces. mike is the proud father. amazing. time for the final call. stacy, kick it off. >> congrats to mike and family. i would consider buying the microsoft august 24 put ahead of earnings. >> scott. >> volatilities come in. that doesn't mean it is not going to go lower. if you're long options, make sure you really want to be long those options. >> dan? >> in apple, turn that august 125, 150 risk reversal into a 150/160 call spread in august. >> buy that one by two put spread. >> looks like our time has expired. go to our website optionsaction.cnbc.com. thanks to the traders. congratulations to mike coe and family. i'm melissa lee. see you back here next week. to.

there's so much to learn. i just shut down. but liberty walked me through it all like,