Friday, November 30, 2012

Morning Update

Yesterday US GDP data showed that the economy grew at its fasted pace since late 2011, though it remains uncertain whether this pace will continue to year end as a result of hurricane Sandy and the Fiscal Cliff. Odds of jumping off the fiscal cliff seemed to increase yesterday as President revealed that his opening demands for a deal are $1.6 trillion in tax increases, $50 billion in infrastructure spending, and the power to raise the debt limit without congressional approval. Reuters reported that the proposal was “greeted with laughter” from congressional Republican leaders and it appears it is a step back rather than a step forward in the negotiations.

On Tuesday the Durable Goods report for October showed orders were unchanged, mainly due to weakness in auto sales, airplanes, and defense. However, yesterday Ford announced that it is on track to have its best Hybrid sales month ever and increase its electrified car market share to 11%, a 5 fold increase year over year. The primary driver of this growth in the US is Ford’s new C-MAX hybrid. In October, the first full month that C-MAX hybrids were sold, Ford outsold the Toyota Prius 3,182 to 2,769 and reported that 70% of buyers were new to Ford. Ford also continues to break sales records in China due to the popularity of the Focus there. Ford has posted back-to-back record breaking Focus sales in China the past two months which has helped send wholesales up 14% year to date.



Option traders have been buying calls on the stock on the news of these record sales. Yesterday the stock jumped 2.5% higher and 2.7 calls traded for every put. The biggest trade of the day was the purchase of 8,418 January 11 calls for $0.68 with the stock at 11.40. This is a bullish bet that Ford will be above 11.68 at January expiration, or 2.5% higher.

Buying calls on the stock is the best way to play this name because of how volatile durable goods sales have been in the US and abroad. Although sales appear strong in the US and China, they are down 11% year to date in Europe as the economy continues to weaken there. Buying a call removes a lot of the downside risk of owning the stock, yet allows you to profit if the stock rallies into their January earnings announcement, which is likely to show a strong quarter.

Thursday, November 29, 2012

Bullish GMCR Options Activity

After the close on Tuesday Green Mountain Coffee Roasters reported better than expected fourth quarter earnings that sent the stock up 27% yesterday. One trader decided to play the rise in the stock with options, and bought 24,000 Dec. 33 calls for $3.85 with the stock at 35.89. This is a bullish bet that the stock will appreciate by at least 2.7% over the next 22 days.

This bullishness comes after GMCR reported EPS of $0.64 versus expectations of $0.48, net sales increased 33% year over year, and next year’s guidance was raised. GMCR has been beaten down by the market and is currently 68% off its all-time high from 2011. The stock’s downfall began in 2011 when David Einhorn made a strong bearish case for the stock at an investment conference. His thesis for shorting the stock was the K-Cups are more expensive than buying traditional coffee grounds and wouldn’t catch on with consumers making the company’s growth unsustainable and the stock overvalued. Then in April of this year Starbuck announced it would be entering the single serve coffe market as a competitor to GMCR, which sent shares tumbling further.

However, this earnings report suggests that the increased competition is not hurting GMCR as much as anticipated and that consumers are accepting the idea of K-Cups, along with their price. Years ago critics of Starbucks said the company’s business model would fail because its coffee was overpriced, but today few complain of Starbuck’s prices because consumers have adjusted to Starbuck’s prices. GMCR is a similar story and the fact that Starbucks is entering the field goes to show how mainstream the single-serve coffee industry is.

The pop in the stock yesterday was primarily driven by short covering. Short interest has been building in the stock since this summer and peaked at 33% at the beginning of November. This stock is likely to see some analyst upgrades after this blow-out quarter, which could drive more short covering in the near term and send prices higher. I don’t necessarily want to own the stock here, now that it is already over 25% off its lows, but would be willing to take a chance that the stock continues to appreciate off of its newly found momentum with some calls.

Wednesday, November 28, 2012

Bullish Options Activity in GLD

Today one option trader is taking advantage of gold’s decline by buying upside calls. The biggest trade of the day is the purchase of 7,250 GLD January 2014 calls for $4.35. This is a bullish trade that profits if GLD is above 204.35 at January 2014 expiration, which is 415 days away and a 23% move higher. The 200 level in GLD corresponds to a spot gold price of about $2100/oz.

Gold fundamentals remain strong going into 2013, and while I don’t expect gold to trade to $2,100/oz in the coming year, I do expect gold to appreciate significantly. This is based on simple supply and demand. The supply side of gold is not expected to increase dramatically next year, but demand should continue to grow. The two primary sources of gold demand are central banks and exchange traded funds. In 2011 net central bank purchases exceeded 455 tonnes, the largest since 1964. This year the World Gold Council has reported that net central bank purchases are about 20% of global supply. Meanwhile, demand for gold from investors has also been strong, which has led to over $200 million in inflows to GLD this month alone.

I trade gold based on a fundamental macroeconomic model, which currently suggests gold’s fair value is $1785. I am closely watching the Fed’s activity and how it affecting the US monetary base, as well as movements of the Euro, bonds, and the unemployment rate. While we are certainly bullish on gold, our model suggests that $2,100 is not a realistic target given current fundamentals. Therefore I would not hold this option to expiration, but the 200 call is likely to appreciate in price in the near term on a pop in gold.

Tuesday, November 27, 2012

Morning Update

Overnight another Greek bailout was agreed to, which has sent the Euro lower against the dollar. In the past these events have been a “buy the rumor, sell the news” events, so today’s price action is no surprise. And as with the past Greek bailouts, analysts are already saying that it is just kicking the can down the road without a real solution. The main economic news out of the US this morning is the durable goods numbers, which came in ahead of expectations, though expectations were exceptionally low. The October number was unchanged following a 9.2% increase in September and massive 13.1% drop in August. The chart from the Federal Reserve, shows capital goods orders with formal US recessions highlighted in grey. If the recent drop in durable goods orders continues, the trend shows that the US is likely headed for a recession.


One of the sector’s hardest hit since President Obama’s reelection has been the Utilities. The SPDR Select Sector Utilities ETF, XLU, is down 4.8% versus a 0.60% decline in the S&P 500 since the election. Yesterday one option trader made a bet that this sell off was overdone and that the XLU is due to rally into the end of the year. The biggest trade of the day was the purchase of 36,766 Dec. 35 calls for $0.23 with the stock at 34.56. This is a bullish bet that will profit if XLU is above 35.23 (1.9% higher) at December expiration in 24 days.

The utilities sector has sold off since the election on fears that taxes on dividends will rise. The utilities sector has traditionally paid some of the highest and most consistent dividends in the market, but will lose some appear if dividend tax rates increase. However, at current prices the utilities are starting to look like a bargain, which has led this option trader to make a bullish bet.

By buying the Dec. 35 XLU call option, this trader has locked in the ability to purchase the ETF at 35 at December expiration. At this level the stock will yield 3.8%. Historically Utilities have traded with a discounted yield to investment grade corporate debt, but ITR, the SPDR Barclays Intermediate Term Corporate Bond ETF, is currently yielding just 3.2%. This could be a sign that XLU has been oversold and due for a pop. If the XLU were to move higher such that it yielded 3.2% like the corporate bond ETF, it would be at 41.00, or 19% higher than yesterday’s close.

Considering the XLU has a better yield than investment grade corporate bonds and also, unlike bonds, maintains the opportunity for significant capital growth, buying calls here is a low risk, high reward trade that locks in what is likely to be an advantageous entry point.

Monday, November 26, 2012

Morning Update

Last week the market rose on optimism that there will be resolutions to the debt crisis in Europe, the fiscal cliff in the US, and conflict in Israel. However, no real solutions were actually found to any of those problems last week. Therefore, we remain cautiously long in this market and are watching the price action in the S&P closely. There appears to be major headline risk in this market, and it will only take one comment from a congressman about not compromising to send this market lower. The focus this week will be on congress, durable goods orders, and GDP and the levels we are watching in the S&P 500 futures are support at 1390 and resistance at the 100-day mobbing average at 1405.

One stock that saw a surge of interest and high trading volume during Friday’s abbreviated trading session was RIM. Shares closed up over 13% on the day following an analyst upgrade and upward price target revision to $15. On trader bought 11,055 March 18 calls for $0.47 with the stock at 11.57. This is a bullish bet that the stock will climb at least 33% over the next 109 days.

Why so bullish? It all comes down to expectations for BB10, RIM’s newest operating system. Earlier last week Jefferies upgraded the stock after a survey showed “a much more positive view of BB10 then we expected.” National Bank Financial upgraded the stock Friday because they expect BB10 to launch in multiple countries on January 30th, with shipping starting soon after. They said most analysts earnings estimates reflect a March launch date.

While some stock and option traders may be jumping into the stock here ahead of the launch, I am still hesitant. First, this could be a buy the rumor, sell the news scenario. RIMM is already up 87% off its 52 week low made on 9/26 meaning the company will need fantastic earnings in order to stay ahead of expectations. The company’s last earnings report showed significant declines in years over year EPS and revenues so buying into the stock now is a complete bet on BB10 turning the company around. It is important to note that BB10 will be releasing after the important holiday shopping season, which will further disadvantage it to competitors Google and Apple. If you do think BB10 will be a success, then buying the March 18 calls like this trader did is the way to go. Risk is limited in this trader to the $0.47 premium paid, but the returns in the event RIMM shows earnings growth could be huge.

Wednesday, November 21, 2012

Morning Update

This morning jobless claims were released due to the holiday and were in line with expectations at 410K. Last week’s claims were revised up from 439K to 451K. The Euro was volatile overnight, first falling on news that no agreement over Greek aid disbursement have been reached. However since then the Euro has traded all the way back and is now up on the day. Today’s US trading session is likely to see light volume ahead of the holiday.

Yesterday I noticed unusual options activity in Halliburton. One trader bought 3827 December 30 puts for $0.54 with the stock at 31.35. This is a bearish bet that will profit if HAL is below 29.46 (6% lower) at December expiration in 30 days. Halliburton is a high beta stock that was down over 20% from its September highs before rebounding a few percent with the broad market this week. This trader is taking advantage of this bounce to get bearish exposure to the stock, and also take advantage relatively low implied volatility. Thirty day implied volatility in HAL is currently 27.32, which is near the bottom end of its 52-week range of 25.13 – 60.80. If HAL sells off like this trader expects, implied volatility will increase as investors rush to buy puts to protect their stock positions pushing the price of these puts up even more.

Right now Halliburton’s technicals are bearish. The stock made a head-and-shoulders top on its daily chart over the last few months. This price pattern would suggest the stock trades down to 28.00, which also coincides with previous area of major support and is near the stock’s 52-week low. Fundamentally, the stock also faces some headwinds. During the company’s last earnings report David Leasar, the company’s chairman, president, and CEO, said “We expect the next couple of quarters to be pretty bumpy.” That’s because of price volatility in guar gum, a key material used in hydraulic fracturing led Halliburton to hedge at an unfavorable price which has left them stock with huge amounts of overpriced investory. Another reason is that Halliburton’s North American customers are cutting back spending due to high costs and low energy prices. Relative to the third quarter of 2011 there are 6.5% fewer rigs in North America, which means fewer customers for Halliburton. Halliburton’s international operations remain strong, but may not be stellar enough to drive substantial growth going forward.

I like this trade for playing a near-term sell off in the stock because it has a very favorable risk-reward ratio. If Halliburton does trade down to 28, this option will return $1.46 in profit, but can only loose $0.54 in the event that scenario does not play out.

Tuesday, November 20, 2012

Morning Update

Last night moments after the US close Moodys downgraded French debt from Aaa to Aa1. The biggest reaction to this was in the EUR/USD rate, which slipped from 18.15 to 1.2765 in minutes. However, the Euro completely recovered as soon as European markets opened for the day and is now sitting at 1.2800. European markets are basically unchanged this morning, along with US stock futures. Housing starts were reported at 0.894M this morning, beating consensus estimates of 0.836M.

Yesterday Wall Street was in rally mode as traders snapped up “risk-on” positions. We noticed unusual options activity in EWZ, the iShares MSCI Brazil Index. One trader bought 40,000 March 53/55 call spreads for $0.77 and also sold 20,000 March 48 puts for $1.54 with the ETF at 51.68. This is a bullish bet that will profit if EWZ is above 55 at March expiration. That would require a 6.4% move over the next 115 days. If EWZ sells off and is below 48 at expiration, the trader will be put to 2 million shares there. By selling this put the trader is indicating they he is willing to buy the stock at that level, which coincides with the ETF’s 52-week low.

The Brazil ETF is down 9.3% year to date on slowing growth in the Brazilian economy. Brazilian GDP growth has slid from a high of 9.3% in Q1 2010 to 0.5% last quarter. The Brazilian government has tried to stimulate growth by lowering interest rates and cutting taxes, but it has yet to be enough. However, if there is a rebound in global trade and growth EWZ is likely to bounce back more rapidly than the developed economies of the US and Europe. This trade will be a winner if the global economy shows signs of improvement. Stronger growth out of China, a resolution to the fiscal cliff in the US, and a solution to Europe’s debt problems would give investors the confidence to move money in more lucrative markets like Brazil. However, that scenario remains in the distant future. Despite yesterday’s pop in the S&P 500 French debt was downgraded yesterday and US industrial production numbers plummeted to multi-year lows last week. Until the data shows a rebound in the global economy my portfolio will be on the defensive side.

Friday, November 16, 2012

Twilight Finale

LGF is releasing its final movie of the teen mega blockbuster twilight today. The franchise has been widely popular and has been a boon to the relatively small movie production company Lions Gate Films. Typically upon movie releases for LGF we see a run up in the stock prior to the release and then a sell off upon release. Typical for Hollywood to buy the rumor and sell the news. There are signs this time might be different, Early returns are already strong, with one report stating that the film grossed 30.4 million from screenings at 10 pm last night and at least one investor is planning on this final addition to buck the trend and beat expectations on this opening weekend. In one trade an investor bought 600 December 17 calls for .29 cents. He is outlaying $17,400 to get long 60,000 shares over 17. This is an attractive way to play the upside in this stock; we have a defined risk, and don’t lose any more than our original capital if the stock does indeed sell on the news.

Morning Update

Since the election the Russell 200 is down 6.3% while RVX, an index that applies the VIX calculation to the Russell 2000 to track implied volatility, is up only 2.7%. Typically we would expect implied volatility to increase 4% for every 1% down move in the stock market, and the breakdown of this relationship suggests that there is no panic selling going on right now. Implied volatility has been kept low because option traders are selling puts into declines in the Russell as they choose levels they are willing to buy the market. Yesterday the largest trade of the day in RUT was a spread known as an iron condor. This spread involves selling an out of the money bull put spread and an out of the money bear call spread. This trader chose to sell 1602 Dec. 700/690 put spreads and sell 1244 Dec. 830/840 call spreads for a net credit of $1.15. At December expiration, which is in 34 days, RUT is between the spreads short strikes (700 and 830), all of the options will expire worthless and the trader will get to keep the credit collected. If RUT breaks out of the 690-840 range, either to the upside or downside, the spread will realize its maximum loss.

Traders sell iron condors when they believe the market will be range bound and that implied volatility overstates how much the market will actually move. Therefore iron condors are sensitive to changes in implied volatility and can be used to profit from a declining VIX, or in this case RVX.

But why bet on a decline in the RVX now? One reason is seasonality. Typically the December expiration cycle is a good time to short volatility because all of the exchange holidays and light trading volume mean there are fewer days for the market to make a big move. Another reason is that any good news, either of a Spanish bailout or progress on solving the fiscal cliff, will send this market higher and bring implied volatility crashing down.

By selling this particular spread, which has an exceptionally wide range where it can profit in, and market implied 88.50% chance of success, the trader demonstrating uncertainty about where the market will go and merely wants to collect some money by choose levels he or she is confident the market will not close above or below. While this spread has a high probability of making $1.15, it could lose as much as $8.85 if the market trends one way or another. Therefore traders planning to trade it must be prepared to hedge the position with stock or other options if the market moves against them, or size the position so that the maximum loss can be taken without too much pain.

Thursday, November 15, 2012

Morning Update

Overnight trading saw a risk-off environment as headlines showed Europe has fallen into another recession, their second in four years. This news should not surprise anyone. What is most concerning is that October Eurozone CPI came in at 2.5%, suggesting the Eurozone could be entering a period of stagflation. In Japan the opposition leader called for unlimited BOJ easing, which has caused heavy Yen selling against all major currencies. In the US this morning the October CPI was reported in-line with expectations at a 0.1 M/M increase. Jobless claims, however, were well above expectations for 361K, coming in a 439K. This is likely a distortion in the data caused by hurricane Sandy and the S&P 500 futures are little changed after the data release.

Yesterday October retail sales data showed a seasonally adjusted decline of 0.3% versus expectations of a 0.1% decline. This was the largest drop since June and followed a strong 1.1% advance in September. The SPDR S&P Retail ETF, XRT, sold off 1.2% yesterday, which was in line with the S&P 500’s decline. XRT saw heavy option trading yesterday as traders rushed to buy puts, sending XRT’s put/call ratio to 50.6 for the day. The biggest trade of the day was the purchase of 23000 Dec. 60 puts for $1.67 and the sale of 23000 Dec. 56 puts for $0.49. This is known as a bear put spread and will profit if XRT is below 58.82 at December expiration. Traders use these spreads when they are bearish on a stock and sell a further out of the money put in order to subsidize the purchase of a closer to the money put. This decreases the total premium paid, which reduces risk, but also limits profits. If XRT is below 56 at expiration this spread will realize its full value of $4.00 and return a profit of $2.82 or 239% return on risk.

Digging into the numbers of the retail sales report reveals some concerns, which is why traders bought so many puts yesterday. The only sectors that saw a meaningful increase in sales were service stations and grocery stores. Auto dealerships saw a 1.5% month over month decline, the largest drop in a year. Service station gasoline sales jumped 1.4% last month, which, if omitted, mean retail sales fell an even sharper 0.5% last month. Grocery store sales were likely up as a result of Hurricane Sandy and do not represent real demand or growth. Sales that I would have expected to be up because of the storm, such as home improvement stores, actually declined. This report was clearly affected by the storm, which has increased the volatility in recent economic data. Retail sales reports are typically volatile to begin with, and it is not uncommon for large increases to be followed by declines. Therefore I am not getting short the retail sector, but I do feel that long stock positions should be protected by puts or put spreads. There is no denying that this was a poor report and that could lead to more selling in the coming days.

Wednesday, November 14, 2012

Morning Update

This morning futures are modestly higher head of the open with the Euro up 0.30% and European indices down. Today retail sales were released for October and came in at -0.3 versus -0.1$% expected. The reading was likely affected by hurricane Sandy, but the bottom line is that ales slowed after accelerating the month before. The PPI was also release this morning and like retail sales came in weaker than expected. Consensus estimates were for a 0.2% increase but the PPI was reported at -0.2% month over month. Food inflation rose 0.4% last month but energy decreased 0.5% led by gasoline prices, which eased 2.2%. The market will be closely following President Obama this week and into next as he aism to begin congressional budget talks this Friday. He is said to be calling for $1.6 trillion in tax revenue increases over the next 10 years, which is likely to be rejected by Republicans.

This morning 773 million Facebook shares will be free to hit the market as another stock lock-up expires. There are currently 2.3 billion shares circulating, so the new shares eligible to be traded today represent an increase of 33%. In the past Facebook’s stock price has tumbled on lock-up expiration days. This time, however, traders do not appear to be making as bearish bets as in the past. According to the WSJ the number of Facebook shares being borrowed to short has declined by 40% this month and is at its lowest level since June. The cost of borrowing Facebook shares has likewise been halved as demand is no longer there. Yesterday Facebook puts were very active, but mostly on the sell side. One trader sold 12,590 Nov. 19 puts for $0.30 with the stock trading 19.95. This is a bullish to neutral bet that Facebook will not decline below 18.70 (6.2% lower) by expiration this Friday. If Facebook is below 19, the trader will be put to the stock there, but regardless the trader gets to keep the $0.30 in premium received for writing the puts.

Prior to past lock-up expirations we have seen heavy put buying, so yesterday’s options trading was quite different. In total $1.6 million in put premium was sold yesterday on over twice the average daily trading volume. Selling an out of the money put is a bullish to neutral strategy, and by employing it yesterday traders are saying they think Facebook will not decline much more this week. The reason for this bullishness is simply that Facebook could be oversold – share are already down over 50% from its IPO price and down over 17% since it reported better than expected earnings on Oct. 23rd. The lock up could already be priced into the share’s price, making today a near term bottom. However, the fact that traders are selling November puts and not December or further dated contracts is telling that the risk in the stock over the long term remains to the downside.

Tuesday, November 13, 2012

Morning Update

Yesterday one of the worst performing sectors was the homebuilders. The SPDR Homebuilders ETF, XHB, sold off 1.5% to close at its 50-day moving average. The ETF saw heavy option volume yesterday, most of which were puts. Over 8 times the average daily put volume traded and the put/call ratio was 12.8. The biggest trade of the day was the purchase of 21,000 Jan. 24/22 put spreads for $0.42 with XHB trading at 25.56. This is a bearish trade that profits if XHB is below 23.58 at January expiration. This would require a 7.7% decline over the next 67 days. This spread will realize its full value of $2.00 if XHB is below 22 at expiration, which will return a profit of $1.58 or a 376% return on risk. However, if XHB is above 24 at expiration this spread will be worthless.

Data suggests that the US housing market has bottomed, so why all the bearishness? Yesterday a component of the XHB, DR Horton Inc (DHI), reported earnings that beat EPS forecasts but missed on revenue. And last week Zillow, an online realtor, guided below what the street was expecting for Q4. This comes in contrast to housing data and suggests that momentum may be waning for the homebuilding sector. XHB is up 45.6% year to date, so these earnings and guidance misses are likely to cause some profit taking, especially ahead of the uncertainty surrounding the fiscal cliff.

This option trader’s spread targets a move to 22 for the XHB, which is currently the ETF’s 200-day moving average. A test of the 200-day is likely to be determined by the guidance the rest of XHB’s components deliver. Home Depot, XHB’s largest component, reported this morning with a beat and guided up, which is likely to lift the homebuilding sector after yesterday decline. If you want to get bearish exposure to the sector, consider today’s strength an opportunity. But use spreads like this to keep risk fixed and reward/risk ratios high in the event the 50-day moving average holds as support for the XHB

Monday, November 12, 2012

Morning Update

This morning US equities are pointing towards a higher open despite lower markets across Europe. European stock indices have been trending lower after the decision on Greek aid scheduled for today was delayed. Fitch said saying they feel Spain’s debt rating is appropriate but Moody’s said that the ECB is only buying time for the Euro and their decision on France’s rating will be released in a few weeks. This has Spanish-German 10yr bond spreads widening to 450 bps, which is significant because it is the threshold where the LCH, a European clearinghouse, begins reviewing bonds eligibility to meet margin requirements.

One sector that has showed relative strength during last week’s broad market decline was the consumer discretionary sector, XLY. XLY is one of the best performing sectors year to date, up 15.43% versus an 8.36% gain for SPY. However, one option trader is betting that the good times are over for this ETF. The biggest option trade on Friday was the purchase of 2500 March 46/40 puts spreads for $1.69 with the ETF at 45.74. This is a bearish spread that profits if XLY is below 44.31 at expiration or 3.1% lower. This spread, known as a bear put spread, has defined risk and limited profit potential. The maximum loss this spread can incur is the premium paid or $1.69. If XLY is below 40 at March expiration (124 days away), this spread will realize its maximum value and return a profit of $4.31 or 255% return on risk.

Why get bearish on the Consumer Discretionary sector now? This is likely the expression of a broad view that US consumer spending will slow into the holiday season ahead of the fiscal cliff and slowing global trade. The last personal income report showed that consumer spending rose 0.8%, ahead of estimates and the largest gain since February. However, since disposable income growth– i.e. personal income after taxes and inflation, has been flat, it means that consumers used saving to finance their spending. This is not a sustainable way of fueling economic growth and means the next consumer spending report, due out on November 30th could disappoint the market. This morning the Japanese GDP report showed the economy shrank last quarter, and last week Mario Draghi stated that the debt crisis’ drag on the German economy is growing. With several of the world’s major economies slowing, the US could be the next. This is a low risk, high reward to play slowing consumer spending, which accounts for 70% of US economic activity. Because of the low risk, high reward nature of this spread it could also be used to hedge a portfolio of consumer discretionary stocks that could sell off if the US economy’s growth rate slows.

Friday, November 9, 2012

Morning Update

Yesterday the S&P 500 sold off over 1% and the VIX also sold off over 4%. Typically for a 1% down move in the S&P 500 the VIX will move up by 4%, so yesterday’s price action was very atypical and is a bullish indicator. The VIX moves up when the S&P moves down because traders bid up the cost of out of the money puts in order to protect their portfolios from further declines. Yesterday we saw traders doing the opposite: selling puts at levels they were willing to get long the market. The biggest trade of the day in SPY options was the sale of 48,000 Nov. 136 puts for $0.53 with SPY at 138.75. This trade will profit as long as SPY is above 135.47 (2.4% lower) at November expiration, which is in 8 days. If SPY is lower than 136 then the trader will be put to 4.8 million shares of SPY at 136, but regardless the trader will keep the $0.53 in premium collected.

For people who want to begin buying into this sell off selling puts is a good way to go because you can effectively get paid to lock in a price you are willing to buy at. However, selling puts means that you have all of the risk on the downside as a long stock position so you must be comfortable with the risks of owning the stock at the strike price. For people trying to pick a bottom in the S&P 500 but who don’t want to take delivery of the stock I recommend turning this trade into a put spread by buying a deep out of the money put as a hedge.

The case for keeping risk fixed and portfolios hedged is this chart, which overlays the price action around the 1987 crash with today’s market.


Though this doesn't necessarily mean the market will crash today, it is important to remember that it could, and does so unpredictably. We are currently cautiously long the market with tightly hedged positions and are closely monitoring the S&p 500's price action in the vicinity of the 200-day moving average.

Ahead of the open futures are down but off their lows, and given the options order flow yesterday I would be surprised if the market did not at least attempt to reverse some of yesterday’s sell off. Apple has been a great leading indicator of the overall market the past few months and in pre-market trading is up on the day and nearly $10 off its overnight lows, which coincided perfectly with a 50% Fibonacci retracement from its November ‘11 – October ’12 rally.

Thursday, November 8, 2012

Morning Update

Yesterday the market sold off on news that Obama has been reelected and the announcement by Draghi that Germany’s economy is beginning to suffer from the European debt crisis. CNBC showed scenes of violent riots in Greece throughout the day, which also helped drive the market downward. The Greek riots were due to parliament’s austerity vote last night, which unsurprisingly passed. Today attention will be focused back on the US. Jobless claims this morning came in at 355K versus 370K expected and 363K last week. The US balance of trade was also released, coming in at -$41.5B versus -$45.4B expected and -$43.8B last month. The S&P 500 futures are modestly higher ahead of the market open though the better than expected data did not have a profound effect on them. Today we will be closely watching the S&P’s price action around 1402, which is the 100-day moving average, and 1380, which is the 200-day moving average. The market looks like it wants to test 1380, though it could test the 100-day moving average first to get some relief from yesterday’s sharp selloff.

One sector immune from yesterday’s sell off was the gold miners, who finished the day up 1.5% versus the SPY’s 2.3% slide. Physical gold was virtually unchanged in yesterday’s session though it jumped 1.8% on election Tuesday. The miner’s relative strength did not go unnoticed by option traders, who bought upside calls in GDX yesterday. The biggest trade of the day was the purchase of 50,000 Nov. 56 calls for $0.06, the purchase of 10,000 Nov. 52 calls for $0.56 and the purchase of 5,000 Nov. 50 puts for $0.91 with the ETF trading at 50.50. This is a bullish position that will profit from an explosive move upward in GDX over the next two weeks. The breakeven points to this trade are 52.68 (4.3% higher) on the upside and 43.18 (14.5% lower) on the downside. While this trade will make money on a large move lower, this spread was likely designed to be a bullish play that is hedged to reduce losses on the downside.

The reason for this bullishness on the gold mining sector is likely tied to Obama’s reelection, which has traders expecting Ben Bernanke to remain at the Fed and easy money policies to continue. Low interest rates and the potential for inflation down the road are supportive of higher gold prices, which in turn will benefit the gold miners. However, a rise in gold prices does not necessarily translate into an equal rise in GDX. Year to date gold is up 6.8% while GDX is down 5.1%. For this reason I like to trade gold itself, not the miners.

During the first four years of Obama’s presidency gold appreciated 136%, and high reelection means four more years of the same policies that drove gold higher. In the long run I am bullish on gold and expect to see it move higher. However, I trade gold using an economic model which suggests that current gold is trading at fair value. Therefore I am hesitant to buy deep out of the money options on gold or the gold miners, and would recommend anyone doing so to keep their risk controlled with tight hedges.

Wednesday, November 7, 2012

Morning Update

Yesterday as election results rolled in the S&P 500 futures sold off, hitting lows for the night as NBC announced Obama had won the election. After the news the futures rallied to test the 50-day moving average but the level was swiftly rejected as Mario Draghi said the European debt crisis was beginning to hurt Germany, Europe’s largest and most resilient economy. This caused traders to go into risk-off mode, with bonds catching a bid and equities across North America and Europe being sold.

As Americans took to the polls yesterday to choose the country’s new leader, China’s Politiburo Standing Committee is preparing for the 18th National Congress of the Chinese Community Party which will begin Thursday and result in a new ruling elite. Expectations are for Xi Jinping to be named party chief, effective next March. As a result there has been heavy options activity in FXI, the China 25 Index ETF. Yesterday one trader sold 19,875 Dec. 36.5 puts for $0.68 and bought 13,250 Dec. 38 calls for $1.02. The idea behind this spread is to gain long exposure to the FXI via long calls, but to offset the cost of buying those calls by selling puts. This spread was done for a net cost of zero, and will profit if FXI is above 38 at December expiration, which is in 44 days.

The bullish case for China centers around better than expected economic data released this month, and hopes that the leadership will tackle some of the many problems facing the country. China’s third quarter GDP was reported in line with estimates at 7.4%, but new estimates have been revised up from 7.4% to 8.1% growth in the fourth quarter and 9.0% in the first half of 2013. The catalyst for rising growth estimates has been China’s $1T+ stimulus in the past months. Some expect that when new leaders come to power following the National Congress more stimulus will be announced in order to maintain China’s rapid growth.

To play a pop in the FXI following the once in a decade National Congress this spread is worth considering. However, if FXI drops below 36.5, traders will be put the stock and must therefore be willing buyers there. To limit downside risk traders could forego selling a downside put, but this will move the trade’s upside breakeven higher, meaning a bigger move will be required to make a profit.

Tuesday, November 6, 2012

Morning Update

Today is election-day in America and US equity futures are modestly higher ahead of the open despite poor data out of Europe. German Composite PMI for October was reported at 47.7 versus 49.2 last month. Readings like this are consistent with a 0.5% quarterly decrease in GDP. On top of this declines in the France’s private sector over the past two months are the sharpest seen since just after Leman’s bankruptcy in 2009. Nevertheless Europe’s markets are in the green on hopes for that Greece’s newest austerity bill is passed this week. The Euro is well off its lows of the session, which is helping to put a bid in risk assets like crude oil, which is up 1% at the moment.

Ahead of today’s presidential election we noticed heavy call buying in the oil services sector. Call options on Schlumberger were particularly active, with 4.4 calls being bought for every put. The biggest trade of the day was the purchase of 3113 Jan. 77.5 calls for $0.59 with the stock at 69.10. This trader is bullish on the stock and expects it to appreciate by at least 13% before expiration in 73 days. The oil services sector, Schlumberger included has lagged the S&P 500 this year on falling oil and gas prices, as well as oversupply in North America. However, Schlumberger looks poised to outperform the sector going forward due to its strong international presence. Schlumberger also generates $6.49 in cash per share, which has allowed it to consistently buy back shares and raise its dividend 15-20% annually. This likely to drive share appreciation over the long term, but in the short term the stock is likely to be driven by the outcome of today’s election. The Romney campaign has been seen as pro-oil, and a victory could mean opening more land to development by energy companies. This would benefit Schlumberger, who oil companies hire to develop and manage oil fields. Buying out of the money call options on a high quality oil services name like Schlumberger is a good way to play expectations of a Romney victory in the polls tonight because of their fixed risk and potential for unlimited profits.

Monday, November 5, 2012

Morning Update

This morning US equity futures are unchanged after Asian markets closed in the red and European stock indices are down as well. The key events this week will be US presidential elections, a leadership change in China, and an vote on further austerity measures in the Greek parliament. Current polls suggest Obama will be the most likely winner Tuesday night, though it is far from a sure thing. European credit market have started the week trading with a risk off tone ahead of these key events, with the German 2-yr yield dipping into negative territory this morning. The dollar is stronger against the Euro as well, though gold, silver, and crude oil are little changed.

On Friday Chesapeake Energy Corporation’s stock fell 7.9% after the company admitted its debt reduction targets for 2012 may be pushed into 2013, along with some deal closings. This drove unusually high put trading volume in the stock on Friday. The biggest trade of the day was the purchase of 7,000 Nov. 19 puts for $0.67 and the sale of 7,000 Dec. 17 puts for $0.40. By buying a short dated put this trader expects the stock to continue its slide into November expiration next week. However, by selling a December put this trader has picked a level he is willing to buy the stock at, showing that he is bullish in the long term despite expecting short term weakness.

The bearish case for this stock revolves around Chesapeake’s increasing debt and list of unfulfilled promises to investors. Currently the company has about $16 billion in long term debt, which is up from $11 billion last quarter. On Thursday Chesapeake reported a net loss of $2.1 billion after having to write down the value of some assets due to depressed natural gas prices. The company had previously announced it would reduce its debt to no more than $9.5 billion by Dec. 31st, 2012, but recently announced this was more likely to be accomplished in early 2013. To achieve its debt reduction goals, the company planned to sell up to $14 billion in assets this year, but has seen consistently failed to close the deals on the timeline they gave investors.

The longer term bullish case for the stock is that the company will rebound quickly if natural gas prices continue to come off their recent lows. The company’s profits are highly correlated with natural gas prices, and an increase in energy prices will not only increase revenue and EPS, but also allow them sell their oil and gas fields at higher prices. If the company begins to deliver on its debt reduction promises and closes some deals in early 2013, the stock is likely to be gain interest from value investors seeking to profit from rising energy prices. Chesapeake is already on some high profile investor’s radar; Carl Icahn owns over 50 million shares and Mason Hawkins, whose company Southeastern Asset Management, owns 13.9% of Chesapeake and has said he believes the company is 70% undervalued.

Friday, November 2, 2012

Trading the Election

Moments ago we saw a trader buy 51,504 XLV Nov. 42 calls for $0.07 with XLV at 40.40. This is a bullish bet that XLV, the SPDR Health Care Select Sector ETF, will be above 42.07 in 14 days, or 4.1% higher. We think this is actually a bet on the outcome of the election. An Obama victory is likely to benefit healthcare stocks while a Romney victory is likely to benefit the energy sector. Various polls show a wide range of election outcomes, with most showing Obama holding a narrow lead. At the office we like to watch markets like inTrade to see where people are betting their real money. The inTrade market for Obama to win currently implies that he has a 66.3% chance of winning. This trade is risking $360,528 and could potentially make many multiples of that, and shows how some of the smart money is beginning to position themselves for an Obama victory.

Morning Update

This morning October non-farm payrolls were released, coming in at 171,000. This was better than even the best estimate going into the report. However, the unemployment rate did tick up to 7.9%, in line with expectations. This report sent the market higher with the S&P 500 futures now at their 50-day moving average. Gold on the other hand has fallen over 1% and below the psychologically important 1700 level. Our model for gold suggests there is still more downside for the metal, so our positions remain conservative and tightly hedged.

On September 14th the S&P 500 reached its 2012 peak and is down 3% since then. One stock that has not been dragged down with the broad market is Whirlpool, which is up 20% since Sept. 14th and 111% year to date. Yesterday we saw heavy call buying in the stock, suggesting option traders believe Whirlpool’s rally is not over yet. In total 1491 December 100 calls were bought yesterday for $4.50. This is a bet that WHR will be above 104.50, or 4% higher, at December expiration, which is 49 days away.

Whirlpool’s stock has been on a tear lately due to better than expected earnings. The company reported third quarter earnings on October 23rd that blew away market expectations, and also raised guidance for full year earnings. Investors have been attracted to the stock based on its valuation: it has reasonable debt levels, a P/E below the S&P’s, offers a 2% dividend yield, and generates an 11.6% return on equity. However the stock may not have too much more upside before it becomes fully valued. If the stock trades 104.50 like this option trade predicts, its P/E ratio will be exactly in-line with the S&P 500’s. Also, investors should also note that while quarterly earnings have been beating market expectations, growth is slowing. I like the relative strength this stock has shown in recent weeks but would be cautious to buy here. Instead call options make the most sense for gaining exposure to this name because they keep risk limited while offering the opportunity to profit if the momentum behind this stock continues to drive it upward.

Thursday, November 1, 2012

Morning Update


Yesterday US equity trading resumed after a 2 day hiatus due to hurricane Sandy. Volume was a little light but overall trading appeared to be normal. This the ADP employment report was released, coming in at 158,000 versus 155,00 expected and 162,000 last month. However, ADP has switched to a new method for gathering data this month meaning that there is no track record to show how well the numbers will predict tomorrow’s NFP report. Jobless claims were also released this morning, coming in at 363K, down 9K since last week. The market is little changed by this data and looks to open nearly unchanged from yesterday’s close. The e-mini S&P futures tested the 1400 level in overnight trading for the third night in a row, and the level was once again swiftly defended by the bulls. This appears to be a key support level that is likely to be tested in a regular trading session before the market moves higher. 


On Tuesday Ford Motor Company reported an EPS beat for its 3rd quarter earnings. This sent shares 8.2% higher on the day and put a bid under Ford call options. The biggest trade of the day was the purchase of 11,111 Dec. 12 calls for $0.11 with the stock at 10.85. This is a bet that Ford will be above 12.11 at expiration, or 8.5% higher than yesterday’s close. This bullishness undoubtedly comes as a result of Ford’s robust domestic sales, which more than made up for weakness in Europe. Ford’s North American operations posted a pre-tax profit of $2.3 billion, which is the best third quarter the region has ever recorded. This profit was driven by margins, which came in at 12% and attributed to sales of high-end trucks. In Europe Ford posted a $468 million loss and said it could lose up to $500 million next quarter. Year to date Ford has lost $1 billion in Europe, which has led CEO Alan Mulally to announce a major restructuring and layoffs there.

Though Ford’s numbers this quarter are good, it is still unclear if North America can carry the company through a European recession. If Ford’s European restructuring is able to minimize losses while sales remain robust in North America the company will be fine, but that is a big if. To play Ford I like this strategy, which keeps risk fixed and profits from momentum the stock might have after a great quarter like this one. Ford’s chart suggests the stock is likely to test the 12-13 range it traded in during the first quarter of 2012, which would make the Dec. 12 calls a profitable trade.

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