Markets Bet On Sweetened Deal for Countrywide - Forbes.com - Sent Using Google Toolbar

Markets Bet On Sweetened Deal for Countrywide - Forbes.com

Markets Bet On Sweetened Deal for Countrywide
Liz Moyer, 03.25.08, 2:28 PM ET

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A day after rumors of a $6.5 billion first-quarter write-down hit Bank of America, rumors about its acquisition of Countrywide Financial sent ripples through the options markets.

There is speculation that Countrywide (nyse: CFC - news - people ) might get a better takeover bid than the $4 billion Bank of America (nyse: BAC - news - people ) offered in January to buy up the part of Countrywide it didn't already own.

A Bank of America spokesman said the company doesn't comment on rumors or speculation, but added that the deal was on track.

This speculation, of course, comes a day after Bear Stearns (nyse: BSC - news - people ) got a sweetened $10 a share takeover offer from JPMorgan Chase (nyse: JPM - news - people ).

Traders in the options market, who accurately predicted the demise of Bear Stearns (if not helped push it to a foregone conclusion earlier this month) and a higher bid by JPMorgan, piled into April call options on Countrywide Tuesday.

A call option is a bet that the underlying stock will rise. Investors snapped up 12,000 lots of April call options with a strike price of $7.50, which is above Countrywide's price of $6.13 as of morning trading.

The rosier outlook on Countrywide is odd considering it is one of the biggest mortgage lenders and happens to be massively exposed to the subprime market. The company posted a $422 million loss in the fourth quarter, thanks to rising credit costs and write-offs, and conditions in the mortgage market have deteriorated further since then.

Rebecca Engmann Darst, an analyst at Interactive Brokers, the Greenwich, Conn.-based options-market maker, said speculators might be hoping the U.S. Federal Reserve will continue to rescue ailing financial firms by pushing them into the hands of stronger banks.

Bank of America's deal for Countrywide in January was certainly looked upon favorably by the Fed and other regulators, who were concerned that a liquidity-constrained Countrywide could further damage the financial markets already reeling from the credit crunch.

But they weren't directly involved then. Now they are. The Fed was in on the negotiations for JPMorgan's rescue buyout of Bear Stearns and has a vested interest in seeing it carried to completion.

JPMorgan initially offered $2 a share, but Bear Stearns shareholders, 30% of whom are employees, threatened a revolt. Over the weekend, JPMorgan renegotiated the terms, raising its offer to $10 a share but limiting certain guarantys.

The Fed, which pushed the deal as an alternative to bankruptcy and a possibly calamitous effect on the financial markets, has even gone so far as to take $30 billion of Bear Stearns' worst assets and house them apart from the company, to be run off by BlackRock (nyse: BLK - news - people ), so JPMorgan shareholders don't have to worry about big losses.

This is giving reason to think the Fed would step in again. Traders might "be emboldened to make a bid for distressed [companies] if they had some assurance that the Fed had their back," Darst said. "Until last week, that sort of thing just wasn't done."

It's not clear which company would step in to bid for Countrywide, and who else would want to own it. There has also been talk recently that Bank of America should walk away from the deal to shield itself from additional exposure to the most toxic corners of the mortgage market.

Shares of Bank of America were down more than 3% at midday, while Countrywide had climbed 2%.