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Morning Update

This morning US stock futures are moderately higher ahead of the open, driven by an overnight rally in Greek bonds and positive US retails sales. Month over month retails sales came in at 1.1% versus 0.7% consensus. The rest of the week will be packed with data, such as the CPI and industrial production tomorrow, housing starts Wednesday, and existing home sales Friday.

On Friday we noticed unusual options volume in Yahoo. The biggest trade of the day was the sale of 27,000 Oct. 16 calls for $0.09 with the stock trading at 15.88. Next Monday Yahoo will report quarterly earnings for the first time since CEO Melissa Myers took the helm. However Oct. expiration is this Friday so these options will expire ahead of the announcement. This trade is very likely a hedge to a long stock position in a trade known as a covered call or buy-write. This is a conservative strategy traders use when they expect sideways to mildly bullish price action. In this case the trader is being paid $0.09 to forgo any upside gains on his long stock position above $16.00 per share. Since the trader collects $0.09, this trade will outperform a naked long stock position if the stock remains below 16.09 this week. If Yahoo is above 16 the trader will make the $0.09 collected from selling the call plus $0.12 from buying stock at 15.88 and selling it at 16.00, which is a 1.3% return in a week. If Yahoo sells off this week the trader will have the $0.09 collected as a cushion to downside losses in the stock.

Yahoo’s stock has had a strong run-up since September 4th when it traded 14.59 and is nearing a major area of congestion and resistance in the 16 – 16.5 range. For investors who are long the stock but want to reduce some of the stocks day to day volatility, a buy-write strategy like this makes sense. However, since the options in this trade will expire ahead of Yahoo’s earnings it will not dampen the potentially sharp swings the stock could have next week. For investors looking for a little protection from the earnings announcement they should look to sell Nov. call options. These have elevated implied volatilities due to the pending news and will therefore offer sellers large premiums.

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