Back on June 4, we suggested some relatively conservative ways to play the potential downside in Lehman Brothers (LEH). Since we published that piece, the stock has dropped more than 13% to 27.20, and with earnings now behind us it’s time to revisit these positions.

• LEH July 40/42 call vertical - we initially sold this vertical for a credit of $0.34. You could buy it back right now for about $0.05, locking in a gain of 17.46% return on capital risked. Since these calls are now so far out of the money and so cheap, they’re not going to offer much added benefit if the stock resumes its decline, so it’s better to lock in profits here.  If you’
• LEH July 22.5/25/30 put butterfly - we bought this put butterfly for $1.05.  As of Monday’s close this spread is priced to sell at about $1.71, which represents a 62.85% return on capital risked.  There is plenty of time left in the July options, but if Lehman rallies up from here, the negative gamma this trade carries could erode those profits fairly quickly, so again we’d want to lock in these gains.

The interesting thing is that the implied volatility in Lehman options hasn’t declined, even though earnings are out and presumably the worst is (maybe?) behind them.  July options have a 111% IV, and that concern extends all the way out to the 2010 LEAPS, which are trading at 72%.  So if you think the stock still has further to fall, there’s still plenty of premium around to sell (or pay up for, as your tastes dictate).