welcome to "options action" your front row seat to the smart money. i'm melissa lee. here's where the action is tonight. the final stretch. we gave you the play on microsoft. >> one of the strategies that attractive is the august puts. they were offered at 90 cents. >> and now can cisco earnings keep the rally going? too hot. why does this ad have action traders turned on? we'll give you the answer. and twice as nice. stan and mike duke it out on disney. >> the only one who's going to make money is mike's broker. >> they were both right. now we'll see who made the most money.

option action starts right now. >> thanks for joining us in chicago and the city of brotherly love of philadelphia. material, tech and financials leading us through some key technical levels on the s&p 500. does the smart money see the summer realliy getting hotter? let's get "in the money now" and call it the rally that just won't quit. traders continue to buy stocks. since hitting its low in march, the s&p 500 is up 45%. the gains continuing again this week. we saw volatility move sharper as well. is this a sign there's nervousness creaming in on the options market? >> absolutely. actually, there's been some nervousness for a while now. we keep hearing a lot of people saying smart money has been a little bearish. one of the things we noticed this week is s&p 500 was rise and the vix didn't fall. that's usually the relationship we would expect and the

relationship we've been seeing very steadily since the low we saw at the beginning of march. what is this telling us? people are thinking maybe this market is ready to take a lit bit of a breather here or even take a step back before it goes higher if it is going to. >> at the same time, how much more can volatility come in? we've seen it collapse since the highs back in october. are we looking for, you know, the high teen, for instance in the vix in order for us to believe the markets will go higher? >> it's a great point, melissa. i don't think we need to see that. on historical terms, volatility still very high. in more recent history in the last 18 months, it's actually relatively low. so one of the things i think is interesting in a week where we saw volatility tick up a little bit in the price of the vix, we also saw a lot of market commentators and tv pundits. i'm amazed on all your appearances on the networks the last week or so you weren't jumping around like this. a lot of guys are calling for the end of this market malaise we're in. we're in a new bull market. one of the things i'll just say

to you is i think the only remedy at this point is time, okay? and we looked back at the last bubble that burst in 2000. it took three years and took five lower lows. we did go almost 60% off those highs. but here's a really big important but. there were three rallies of 20% off those respective lows. if every pundit and strategist came out and called a bottom in that period of time, it would have been a wrong call. volatility is still relatively cheap and i think there's great opportunities to buy protection. >> where do you fall in this in? >> one of the key points dan brought up that i think is great, markets take time to correct themselves. go back three weeks. i would love to say i called this rally. i didn't come anywhere close to calling this rally. you know why? nothing has really changed in three weeks to make me think that the s&p 500 should be up 12%. so i think fundamental issues are still there with the market. i would anticipate that we do

see continued volatility movements here. that's one of the key points we're seeing. volatility is holding firm because we're actually moving again. the vix is referred to as the fear index. one of the things to keep in mind is it rarely represents movement. as long as we're moving that may continue to stay there. you ask where it can go? 20 is not unreasonable. that's somewhat what the historical levels have been. with it a little bit higher it just means we may see more movement. it doesn't have to be up or down >> where do you see the vix heading and the s&p 500 based on what you're seeing in the option market? >> it's unusual to see the s&p higher on the weeks and the vix higher on the week. that happened 14% of the time. or seven times a year. it's very unusual. but what happens after that? and over time, the week following that, the s&p moves sideways but volatility, measured by the vix continues to move higher. it's up about 1.5% over that

time period. we're going into august. it's not a time we captain lot of market movement but we might get a little volatility. >> deservedly the case, one of the things i would highlight here is if you take a look at the s&p 500, how high volatility is, implied versus realized over the last 30 days. about half of them are cheap to that number. what do i mean by that? >> despite the relatively high level of volatility on the basis of going back two years or something like that, still a lot of these names are trading. the implied price of the option is still cheap to where they're actually trading. >> a key test a lot of traders are looking toward next week. cisco earnings. john chambers on the earnings call will really drive that stock and perhaps the sector as a whole. in august of 2006, bullish remarks from chambers sent shares of cisco 14% higher that day and 68% higher over the

following six months. but a bearish tone nearly a year later sent the stock 60% lower over the following six months. dan, you believe those comments are going to be very key? >> i think lots of savvy market watchers are watching this call. it's very important. he will give a very candid outlook. and one of the things i'll segue -- or a great segue from the last discussion we had. options prices for cisco are very cheap. i think they're underpricing the potential for the stock to move on chambers calling a bomb or saying visibility is still very poor and it's going to take a few more quarters to come out of this. i actually think we can take advantage of the fact that the market is pricing in a 2% move. average move is 4%. melissa told us about two 10% moves after earnings on two individual times that he referenced in '06 and '07.

what do you want to do here? i actually want to be a net buyer of premium. i want to buy the august 22 straddle and pay 80 cents for the august 22 calls and pay 70 cents for the august 2 puts and i need the stock by august expiration to move about 7% either way, up or down. i am not picking a direction here. i need the stock to move. i think the stock has rallied 23% into this call. i think that if he disappoints on the guidance, the stock could very easily retrace half that move and i think you have a cheap options play around something the market is keeping a very close eye on. >> sorry, scott. is this a trade stacey you would put on or be interested in pit putting on or perhaps an ancillary play on technology and its reaction to cisco a better way to go? >> i'm glad dan and i get to talk off camera. our conversations are much more contentious on-camera than off. a couple of things about the strategy, i'm hard pressed to find straddles i like to buy ever. going back to the theoretical world, odds are against you 52-48.

i like to pick a direction. dan called it a hail mary, something to that extent. i knew i would have been better buying a straddle or clearly going bearish with it. that being said, i kind of like to pick a direction if i think it's attractive. cisco trades 30,000 options a day. i tend to think it has a good idea of what the expectation is. i would personally, i would choose just the put side here. i don't know that i would buy the calls. >> scott i want to get you in. sorry to cut you off before. what are your thoughts here?c >> make no mistake. when you buy the straddle here, you're swinging for the fences to continue the sports analogy. the puts still crushed volatility so much that that trade, while it was absolutely profitable, but probably not as profitable as you might have expected given the amount of the market movement. so you have to think that the

same thing might happen here. the volatility is low, but often volatility is low for a reason. so this is really a swinging for the fences play that demands the market to move a ton. because as we've seen, they crush volatility after this sort of catalyst. >> let's move on to the next option here. christmas in july. well, that is the hope of retailers when we get a crucial glimpse on commercial health. our frugal fem fatal, stacey gilbert, she's the only femme besides myself, is bargain hunting. what do you see ahead of the big day? >> we have same-store sales coming up this week and a number of earnings and these retail companies still left to report here. and one of the things that we're seeing is sellers of august volatility.

names like nordstrom's, jwn is an interesting one where they're sellers of august volatility. so i was kind of looking at this, why are they selling august volatility for these two upcoming events? back to school is huge for the retailers. it won't be taken into account until early september. that's going to incorporate all of august. i want to look for a situation where august is really implying a decent, a big move, if you will, compared to september. i think september is where you're going to see bigger names in the retailers. >> what are you playing? >> abercrombie and fitch, i'm selling august volatility because it's trading at a premium to where september volatility is. i'm looking specifically at the 29 strike calls. it's bidding 1.25 and i'm going to finance buying the september 29 call at 1.80. paying 55 cents for the call spread. here's the risk. something comes out in august with their earning or the same store sales and the stock rockets higher. i've basically looking for that

move to be more in september. the other issue is it goats down clearly. >> one of the reasons is when people think about the risk in the stock market they often talk about the month of october. the truth is september can be a very volatile month. if i want to own volatility, that's a place i want to own it. retail space, there's a lot of data points on an ongoing basis. we have some sense of what's going on. i wouldn't anticipate a really shocking move come into these earnings. >> we've got move on here. we have a jam-packed show. well, fans of the late and great walter matthau will certainly know that song. it's "the odd couple." yes, it is time for america's favorite segment, it is time for mike and dan to "put up or shut up." i'm not going to say who's who in the odd couple. safest to stay neutral. this is where they agree on a direction of a stock but disagree over the proper options strategy. procter and gamble set to report

earnings on wednesday. the company is the fourth biggest component of the s&p 500. so a big one that could determine the market direction. dan got the first punch last week. so mike, it is your turn to kick it off. >> this is an interesting story right here. proctor and gamble have reported. the results have been mixed. i don't really know 100% which way i'm going to come out on this thing. usually with a catalyst coming up, i like to sell premium because i think it's overpriced. the thing is premium in this name is incredibly cheap already. i can't sell that front month option without going and buying something else against it. so what i'm looking to do is actually selling the calendar spread. i'm selling the august call and buying the september for 1.30. i'm paying 55 cents for this. if the stock goes higher, i'm probably going to be a winner. if it stays right here i'm going to end up long the september call which i probably prefer to own anyway. that's going to be the play.

>> so neutral to mildly bullish play. dan what's your play? >> just preface this here. stacey comes at me. i never win a bout here. i grow on you a little bit. my wife and i have been married nine years and she's finally coming around. >> took her five years to like you. >> well, maybe. what i want to do is consistent with the theme we've been talking about. here's procter and gamble. not a whole heck of action going on there. this is the fourth largest weighted stock in the s&p 500. we're going to need some other sectors to participate. if the market is going to go meaningfully above 1,000 in the s&p 500 proctor, like i said, fourth largest weighted in the index. i want to buy that 57.50 call in august that mike wants to sell and i'm going pay 85 cents for it and i also want to buy the august 55 put and pay 80 cents for it.

i'm buying the august -- >> you heard the bell. >> i need the stock to move either way to make money and i'm using it as a proxy on the play for the market being at an inflection point. >> make this call. >> you're not going to find this odd and dan, i really like you as a person. i like mike's trade better. a strangle is similar to a straddle for me. again, you're looking for huge movements and probably what works well mike, the entire order flow we're seeing in consumer names like procter gamble and heinz is volatility. i like it. >> who's felix and who's oscar. >> dan's wife just called me and said dan, you got robbed on this one. >> send us an e-mail at optionsaction@cnbc.com. and for a full recap go to our website, optionaction.cnbc.com.

coming up next, you just heard mike and dan go at it. last week they correctly called a fall in disney. we will see which one made more money. time for "pump up the volume." names heating up options traders. this baby boomer play is the world's number one maker of hip replacements. traders were tripping over each other to buy up the calls this week after speculation that johnson & johnson might bay a pretty penny for this purveyor of prosthetics. who is it? the answer when "options action" returns. ense?

sure it makes sense. what bothers me is it's short data. there are different types of trades i like to see to give it more validity, but it does make sense. >> time for a new segment. winners are nice but how about two winner? time for the outside call. we told you how mike and dan duked it out over disney. despite the blood, they're both correct. now they face a common choice.

on "options action" we're always looking for more than one way to make money. case in point, dan and mike's call on disney. >> consumers aren't out there spending. what will that tell you about movies and theme parks and everything disney is involved in. >> both mike and dan suggested bearish options strategy to profit from a disney decline. dan took a conservative tact. >> i want to buy an august 2k6-24 put spread. >> his play, paying 55 cents for the august disney 26-24 put spread where he bought the august 26 strike put for 75 cents and reduced the cost of that purchase by selling the august 24 strike put for 20 cents. but if dan thought disney was heading lower why would he sell the 24 strike put? because no matter how bad disney's earnings were, he

believed the stock wouldn't fall below that $24 level. >> one of the thing i'm playing for is some type of retracement of that 20% move. maybe about 10%. i don't think the stock is going a whole heck of a lot lower. >> so by selling the 24 put, dan makes buying the 26 put cheaper. he doesn't limit the upside as long as disney stays above 24 bucks. but mike went for the jugular. >> i would just buy the 24 put that he would sell. >> mike's aggressive bet paying 20 cents to buy the 24 strike put that dan sold. that 20 cents is the most that mike can lose. but in order to make money, mike needs disney's stock to have a big move lower or fall below the $24 level by more than the cost of the trade by august expiration. one trade, two strategy in a battle royale between puts and probabilities. >> you're killing me. you're absolutely killing me. >> the only person that's going to make money is mike's broker. >> the judge ruled for mike.

>> ain't going to be no rematch. >> and now the debate is tearing the options world apart. >> emotions are reaching a tipping point or a pitting point in the pits of chicago. >> since the time of the trade, both strategies are profitable, as disney stock has fallen 5% on poor results. with the mouse out of the bag a victor must be declared and a move must be made, or both will be losers. that's because with each passing day, mike's put and dan's put spread lose value as those options head towards expiration. with the clock ticking, option actions fans across the universe all want to know the same thing, what will dan and mike do now? okay. so jaba the hut and brad pitt. all of these fans cannot take the suspension.

who came out ahead? if you had followed dan's put spread, you would be up a whopping 55%. mike's out of the money purchase was up, but by only 50%. stacey, you ruled for mike that match as you usually do, but any regrets? >> no, congrats to both dan and mike for great calls, great return there. and dan, kudos to you. you should have won it last week. i do like both of these trades. i still would have done mike, but it looks like dan was the better trade here. >> scott, what do you think? >> in general, i prefer to buy spreads rather than buy outright options, but the story here is that, you know, just a 10 or a 20-cent profit on a relatively low cost spread or option can end up being a pretty good return. so don't discount, you know a 10% or 20% profit. go ahead and take that profit in the market tells you to. >> how are you managing the trade at this point? >> i'm out of it. i risked a small amount of

money. i made a small amount of money. i'm happy about it. that's enough for me. >> i'm staying long this thing. one thing i will mention is some of the names that disappointed like exxon, like mcdonald's, like amazon, they have continued to go lower. i think i'm going to make that whole $1.50 that i set out to make. >> we'll check back with you on that later on. if you have a question, just write us an e-mail. i do real all of those e-mails that come in. go to our website at optionsaction.cnbc.com. time for you to ask the question and time for us to educate you after the show.

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time for "the final call." stacey? >> i'm watching cisco next week. if i'm long the stock i'm definitely considering buying a put. >> scott?a >> i'm watching the vix. it should be up 1.5% next week. >> dan? >> i want to buy cisco next week. the straddle. >> mike? >> i like stacy's call spread. >> go to our website optionsaction.cnbc.com.

thanks for watching. see you back here next week.