The bears are prowling around Lehman Brothers.
Though the stock has stabilized after falling 8% at the end of last week, bets that shares of the company will decline currently outpace bets that shares will gain by more than 7 to 1 in the options markets.
On Tuesday, the most-heavily traded of the bearish bets--called puts--were in $30 contracts expiring in June, meaning these traders see Lehman Brothers' (nyse: LEH - news - people ) shares falling 16% in the next month. A reasonably large group sees the shares falling to $17.50 by then, and a limited number of contracts were out on $5 January options, according to data from Interactive Brokers.
Trading in puts Tuesday was practically calm compared with Friday, when volume nearly reached 200,000 contracts, according to Jon Najarian at Optionmonster.com. Still, 75,000 contracts were trading hands Tuesday, nearly double the normal levels. "Lehman is not out of the woods," Najarian said.
Sound familiar? Furious options-trading preceded the run on Bear Stearns (nyse: BSC - news - people ) in March, including trades in the unimaginably bearish $10 July option, when Bear Stearns stock was trading at $70 just one week before its disastrous fall. The company sold to JPMorgan Chase (nyse: JPM - news - people ) for $2 in a deal that was later revised to $10 a share.
Lehman is acutely aware that speculators are looking for it to fall too, and the company tried to counter by explaining how its case is different. It survived Long-Term Capital's implosion and the Asian currency crisis of 1998, and it will survive now, the mantra goes. It has more liquidity and has been raising capital. For the greater part of the spring, the markets were inclined to agree with Lehman.
But the new negativity surrounding the company comes amid a bunch of research notes lowering expectations for second-quarter results, due out next month. Analysts are now predicting a loss for the quarter after Lehman's management acknowledged a difficult environment.
Speculation is also being aided by David Einhorn, a prominent hedge fund manager who gave a speech last Wednesday evening in New York questioning Lehman's accounting and disclosure. Einhorn "smells a rat, and traders appear happy to seek out potential profits within the options market," said Andrew Wilkinson, a market commentator at Interactive Brokers.
Einhorn, who runs $6 billion asset Greenlight Capital, admits to being short on Lehman, so his fund benefits when the stock goes down. Last Wednesday he questioned a number of recent statements made by Lehman executives and picked apart the company's financial statements, criticizing its disclosures.
Einhorn focused on whether Lehman has been aggressive enough in marking its losses and insinuated the company had been less than forthcoming about its financial statements. Among his beefs, he questioned Lehman's disclosure of $6.5 billion in exposure to collateralized debt obligations (CDOs), about $1.8 billion of which were rated below investment grade, and why the company marked down only $200 million of that exposure in the first quarter.
Lehman had previously been viewed as having limited exposure to CDOs, which are among the derivatives that have caused the most headaches on Wall Street.
Indeed, the mere mention of CDO exposure sends shivers through the markets, and many rival companies, notably Merrill Lynch (nyse: MER - news - people ), UBS (nyse: UBS - news - people ) and Citigroup (nyse: C - news - people ), have taken painful multi-billion-dollar write-downs on their holdings. The initials "CDO" have taken on a notoriety all their own.
Einhorn says this CDO exposure was only reported for the first time in the first-quarter regulatory filing, and in a footnote to a chart, at that.
Lehman contends it was disclosed in the first-quarter press release with earnings, described as "other asset-backed" exposure, and that the use of the term "CDO" in the footnote to its quarterly filing was really more meant as a "catchall" term to describe asset-backed securities.
A spokesman for Lehman said Tuesday that the company would not go through and refute Einhorn's criticisms blow-by-blow. Einhorn concludes that the company should raise more capital and reduce its leverage, adding ominously in the text of his speech, "before federal taxpayer assistance is required."
This worst-case result would be a lot harder in coming, as Einhorn no doubt knows. The Federal Reserve all but insured against another large meltdown by opening its lending window to brokerage companies (including Lehman) and accepting a much broader array of collateral than it previously would. It even stepped in with a $30 billion backstop in the JPMorgan-Bear deal to make sure it would get done.
Still, Lehman needs to close the credibility gap to prevent a repeat. "They have to get through these next earnings without something disastrous," Najarian says. "If the market continues to be turbulent, people are really going to be paying attention to what Einhorn said."
