Bearish options trading (LMT:US) on Lockheed (LMT:US) Martin Corp. surged to a record on Nov. 9 hours before the biggest defense contractor said its incoming chief executive officer resigned because of a relationship with a subordinate.
About 57,000 puts (LMT:US) changed hands on Nov. 9, the most in data compiled by Bloomberg that goes back to 1995. That compares with daily average volume of 940 bearish contracts in 2012. Most of the trading took place around 2 p.m. before the company said Christopher E. Kubasik, the chief operating officer who was slated to become CEO on Jan. 1, left after a probe confirmed a “lengthy, close and personal relationship.”
“This is either a one in 1,000 random event or an egregious example of improprietous trading based on non-public information,” Ophir Gottlieb, managing director at San Francisco-based Livevol Inc., a provider of options-market analytics, wrote in an e-mail. “Nothing is certain, but the odds certainly point toward the latter.”
John Nester, a spokesman for the U.S. Securities and Exchange Commission, and Jennifer Whitlow, a spokeswoman at Bethesda, Maryland-based Lockheed, declined to comment.
Options trading has been implicated in insider cases brought by the SEC in the past, including trading before BHP Billiton Ltd. (BHP)’s takeover bid for Potash Corp. of Saskatchewan Inc. in 2010 and AstraZeneca Plc’s purchase of MedImmune Inc. in 2007. Lockheed shares last week fell the most in a year amid speculation that President Barack Obama would curb military spending after winning a second term.
The management (LMT:US) turmoil compounds risks for Lockheed, which already was under scrutiny for a 70 percent jump in the cost of the F-35 fighter program and faces the threat of automatic defense budget cuts in January.
The 11 most-traded Lockheed Martin options were bearish on Nov. 9, with more than 90 percent of the volume in three contracts, according to data compiled by Bloomberg. About 23,000 January $75 puts, with an exercise price 17 percent below last week’s close, changed hands. Trading also included 20,091 January $80 puts and 10,190 January $85 puts.
Before last week, the previous high in put options trading was in June 2009, when volume reached about 21,600. Some 1,200 calls were traded on Lockheed Martin on Nov. 9, about half of the daily average in 2012.
Call options give the right to buy a security for a certain amount, called the strike price, by a given date. Puts convey the right to sell.
Robert Stevens, Lockheed’s outgoing CEO, had the task of telling the company’s biggest customer that his chosen successor had been ousted in a scandal.
Shortly after Kubasik was replaced at a Nov. 9 board meeting, Stevens called the Pentagon’s top weapons buyer, Frank Kendall, to let him know of the sudden turn before it was made public, according to two people familiar with the situation who asked not to be identified because the communications were private.
“Our initial contacts with our Department of Defense customers” came after the market close at 4 p.m. New York time that day, Stevens said today on a conference call with analysts
Then Lockheed announced at 4:34 p.m. that Kubasik, instead of becoming CEO on Jan. 1, was forced out. Marillyn Hewson, 58, and a three-decade employee, was named president and chief operating officer immediately and will become CEO when Stevens steps down at year-end. Stevens, 61, will become executive chairman in the transition.
The Defense Department’s initial response has been “an understanding of the actions that we’ve taken, and a full measure of support for Marillyn in her new position, along with, I think, a very consistent request of all of us: Don’t lose focus on the commitments that you’ve made,” Stevens said today.
Kubasik’s conduct “was a personal failing, having no impact on either our operational or our financial results,” he said.
Lockheed shares (LMT:US) lost 4 percent to $89.98 last week, trimming the advance for the year to 11 percent. The company’s shares seldom change hands after hours and on Nov. 9 there were only two 100-share trades after news of the resignation broke, at $89.70 and $89.95.
Lockheed fell 17 cents to $89.81 today at the close of New York trading.
“A change in leadership can be disruptive,” said Richard Aboulafia, vice president of analysis at Teal Group Corp. of Fairfax, Virginia. “But it could be the company needs to change its approach.”
Hewson may have to redouble Lockheed’s efforts to improve relations with Pentagon officials, particularly on the F-35 Joint Strike Fighter program, the company’s single largest program and the Pentagon’s most expensive weapons system.
Eighty-two percent of the company’s $46.5 billion in revenue (LMT:US) last year came from the U.S. government, mostly from the Defense Department, according to the company’s annual report.
Lockheed was the Pentagon’s biggest contractor in the government’s fiscal year that ended Sept. 30, 2011, with $36.4 billion in direct, or prime, awards, according to a Bloomberg Government study on the top 200 contractors.
The company is in the midst of a prolonged negotiation with the Pentagon on orders for the next batch of F-35s, and the program has faced cost overruns and testing delays. Buying a planned inventory of 2,443 F-35s for the Air Force, Navy and Marine Corps is now estimated to cost $395.7 billion, a 70 percent increase since Lockheed won the contract in late 2001.
The deputy head of the Pentagon’s F-35 program, Air Force Major General Christopher Bogdan, said in September that his office’s relationship with Lockheed had deteriorated to “the worst I’ve ever seen.”
Hewson said on the call today that she’s been “very much engaged” in F-35 negotiations with the Pentagon.
“I know the Department of Defense team for the F-35,” she said. “We won’t miss a beat on F-35.”
The F-35 will be Lockheed’s “growth catalyst” for years to come, said Brian Ruttenbur, an analyst at CRT Capital Group in Stamford, Connecticut. He said the company has the executive depth to oversee the F-35 and other programs in Kubasik’s absence.
“This is a big company with a lot of seasoned management,” Ruttenbur said in a telephone interview. “They’re going to get through this.”
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