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Morning Update

Yesterday Spain presented a budget that included spending cuts, no tax hikes, and an optimistic view of economic growth next year. This sent US stocks higher on the day which spilled over into China’s Hang Seng. However, this morning in Europe is lower and Spain’s benchmark IBEX index is set to close down 5% on the week. Later today the results of Spanish bank stress tests are due which could be market moving news.

Yesterday’s unusual options activity occurred in YHOO and GLD. Yahoo’s stock has had a tough year; down 1.5% while the S&P 500 is up 13.3%. But one options trader is better that the company has better times ahead of it. Yesterday we saw someone buy the November 17/18 call spread for a net debit of $0.12. This is a bullish spread that returns $0.88 if YHOO is above 18 at expiration and only looses $0.12 if YHOO is below 17 at expiration. With YHOO closing yesterday at 16.04, this option trader is expecting the stock to appreciate 12% over the next 49 days.

There are several possible reasons for this bullishness. First, Forbes reported yesterday that Eric Schmidt of Google said he is interested in a search deal with Yahoo. In addition to this deal, Yahoo has recently replaced its CEO and CFO in order to revitalize the company. This morning Goldman Sachs reinstated coverage of YHOO with a buy rating and price target of $22.

Yahoo’s fortunes could be changing but until the company gains some traction we like playing it with low risk, high reward spreads like this instead of buying the stock.

Another unusual options trade yesterday was on GLD, the SPDR Gold Trust ETF. One trader sold the Dec. 170 straddle 16,000 times for $10.70. Traders put spreads like these on when they expect sideways price action in the underlying stock and expect implied volatility to decline. This particular trade will be profitable if GLD is between 159.30 and 180.70 at December expiration. Implied volatility in GLD options have been declining since making a multi-month high on Sept. 12th, but ticked up yesterday as GLD rallied. This trader used this opportunity to short implied volatility at a favorable price and is betting the trend downward will continue.

After gold’s recent run up we think GLD is likely to pause here and move sideways to build a base and consolidate. However, we do not like to trade short straddles because they have unlimited risk. Instead we prefer to sell calls against stock to protect the position from some downside and generate income in a sideways market.

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