The Wall Street Journal reports (subscription required) that Altria Group Inc. (NYSE: MO) has agreed to acquire UST Inc. (NYSE: UST) for $10.3 billion in cash. According to the Journal, "The deal would give Altria a strong foothold in smokeless tobacco, a growing area of the market where it has had difficulty making inroads against long-established brands."

The deal diversifies Phillip Morris away from cigarettes -- a business that's declining by 3% or 4% -- and into the smokeless tobacco business that's increasing in the 6-7% range.

What is interesting about this deal is that it also acquires more of the potentially-disastrous legal liabilities that come with selling and aggressively marketing a product that causes people to die a slow and painful death -- Altria is apparently betting that the legal liabilities are already priced into UST stock. If they're right about that, it bodes well for the tobacco industry as a whole.

UST owns the Skoal, Copenhagen, Red Seal, and Husky smokeless tobacco brands, and also has interests in alcohol through its Ste. Michelle Wine Estates business.

The New York Times reports that Altria Group (NYSE: MO) "is in advanced talks to buy UST (NYSE: UST), the maker of the popular Skoal and Copenhagen smokeless tobacco brands, for more than $10 billion." Investors are reacting positively to the news, sending Altria shares over 1% higher.

Since spinning off Philip Morris International (NYSE: PMI) in March, Altria expected to experience sales decline. U.S. cigarette industry has been on the decline for years and Phillip Morris USA indeed saw an adjusted 3.6% drop in sales last year. The company has projected the trend will continue and cigarette sales volume to fall between 2.5% to 3% in the U.S. over the next few years. The reasons are knows: concerns about health, smoking bans and price increases. Altria has tried and failed to create its Marlboro brand smokeless tobacco products and has also pulled the plug on Marlboro Ultra Smooth, which despite using better filters didn't see higher consumer acceptance.

A wise investor never lets a perceived vice get between him and a nice profit. So no matter how you feel personally about booze and chewin' tobacco, read on.

Goldman Sachs just issued a report today upgrading UST Inc. (NYSE: UST) to a BUY. UST Inc is a holding company not just for U.S. Smokeless Tobacco Company, which makes smokeless tobacco products (that's chaw to you and me) under the Copenhagen and Skoal brand names, but also for the wine brand, Ste. Michelle Wine Estates, that produces wine under the Chateau Ste. Michelle and Columbia Crest (contributing 15% of total sales).

Sold mainly in the U.S., this is an example of a company that some people don't necessarily feel comfortable supporting -- booze and chewing tobacco. But if this doesn't offend your sensibilities, the company presents a strong buy opportunity. As Goldman's report states, the market is overestimating the level of competition -- particularly from Marlboro --in smokeless tobacco, where UST makes the majority of its profit.

UST (NYSE: UST) volatility Flat; UST down 6%; Altria Group (NYSE: MO) testing Marlboro Moist Smokeless tobacco. UST, a leading producer and marketer of moist smokeless tobacco products (Skoal, Copenhagen), is recently down $3.06 to $48.91. MO announced the introduction of Marlboro Moist Smokeless tobacco into test market. MO had been frequently mentioned as possibly interested in UST. UST has a market cap of $7.7 billion with quarterly March 2007 total revenue of $447 million. UST September option implied volatility of 26 is near its 26-week average of 23 according to Track Data, suggesting non-directional price risk.

Forest Labs (NYSE: FRX) volatility Elevated on patent challenge Appeal. FRX, a U.S. based pharmaceutical company, is recently down .48 to $37.74. FRX's Lexapro, an antidepressant accounting for 66% of FRX total revenue, is facing a patent challenge appeal.Buckingham Research says "LXP patent challenge appeal which we would expect to be resolved from an appellate decision over the next few months (we expect FRX to prevail in this case)." FRX call option volume of 9,195 contracts compares to put volume of 4,571 contracts. FRX September option implied volatility of 70 is above its 26-week average of 33 according to Track Data, suggesting larger price risks.

Daily options Update is provided by Stock Specialist Paul Foster of theflyonthewall.com.