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Morning Update

Risk assets are higher across the board this morning after the ECB left rates unchanged, as expected. At the December meeting some members of the board had voted for lower rates but today’s decision was unanimous. Draghi cited “considerable” improvement in financial markets as a reason, which has helped to propel risk assets higher. Central banks have effectively removed much of the tail risk in Europe and the US, which has driven the VIX to exceptionally low levels. As long as the situation in Europe continues to slowly progress we expect the Euro to continue to strength as money moves back into high yield credit overseas.

Draghi hinted that the ECB could cut rates, and in today’s press conference he seemed to suggest that this would still be possible in the future. Draghi said there was “considerable” improvement in financial markets and Spanish bonds are trading at

Yesterday Facebook shares jumped over 5% higher on news that the company had invited the media to its Menlo Park headquarters to “see what we are building.” Facebook shares are now trading at levels not seen since July and 80% higher than its all-time lows in September. The rally has been fueled by optimism that Facebook has figured out how to monetize mobile, and option traders are betting that the rally will continue. The biggest trade of the day was the purchase of 3000 January 2014 35 calls for $3.55 with the stock at 29.84.

This trade will profit if FB is above 38.55, 29% higher, a year from now. Considering FB shares jumped 20% after the last earnings announcement this is definitely within the realm of possibilities. Facebook is scheduled to report 4th quarter earnings on January 30th. The stock rallied into the last announcement with implied volatility reaching a peak of 73%. With 30-day implied volatility currently at 55% it seems relatively cheap given the stock’s possibility to rally on the media presentation and earnings. Even cheaper is 360-day volatility, which is at all-time lows (45%). This makes buying long term out of the money calls on the stock an attractive way to play its upside potential. For longer term investors I like swapping out long stock positions for positions in the Jan. 2014 calls at these volatility levels. Swapping stock for calls will allow you lock in profits on the stock and continue to have upside exposure with a fraction of the downside risk.


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