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Morning Update

The week ahead is relatively light on data, with the notable US releases coming on Thursday with Jobless claims and Friday’s International Trade numbers. Overseas there will be an ECB and BOE meeting Thursday, with no expected changes to policy at either. Tomorrow Aloca will kick off another earnings season and are expected to report $0.06 EPS. With the fiscal cliff behind us traders are likely to refocus their attention on US corporate earnings. Expectations to not appear terribly high so strong beats could propel the market higher. In any event the VIX looks poised to jump higher on any downtick in the market after a record sell-off last week. Although the VIX index looks cheap here, the January VIX future is trading at 15.30, which is a 10% premium to the index. The February contract is trading at a 9% premium to the January future. The steep contango in the futures term structure suggests traders expect the spot index to rise and are anticipating increased volatility down the road. At current levels the Jan. VIX future is pricing in 1% daily price swings in the S&P 500.

Yesterday Cheniere Energy made a new 52-week high and closed slightly off that level on news that the company is the first to receive a permit for Liquefied Natural Gas (LNG) exports. The boom in American natural gas production has driven down the price of domestic natural gas by 50% over the last few years. Currency American natural gas costs about a third of what it does in Europe and Asia, which makes shipping LNG overseas attractive. However, options traders were less excited about Cheniere’s move to export LNG as you might expect. The biggest trade of the day was the purchase of 15973 March 20 calls for $1.41 and subsequent sale of 19896 March 22 calls for $0.69.

This type of trade is a call ratio spread, and will profit if LNG is between 20.55 and 29.74 at expiration, with the biggest profit occurring if LNG is at 22, 9% higher, at March expiration. The idea behind this spread is to gain long exposure to the stock by buying calls, but to sell a call at your price target. By selling slightly more calls than you bought you reduce your breakeven cost in the trade and will increase profits if LNG goes to 22 but not past. The downside is that you can lose money if LNG moves down or too far past your target price. The reason for the bullishness on Cheniere is that the company is in a very unique position in America in that it will be the first to be capable of exporting LNG. The company is the first to receive a permit from the US government for exports, and is modifying its new LNG import terminal to handle the exports. These terminals are extremely expensive and time consuming to build from scratch, so Cheniere has a big leg up on the competition by being able to modify its new import terminal. However, this option trader targets $22 for the stock, which is a solid 9% move higher, but not an astronomical move. The tempered bullishness is because it is unlikely this geographic LNG arbitrage will last for long. First, exporting LNG will naturally drive up prices in the US and put pressure on overseas markets. Second, the process of processing and shipping LNG is costly and will cut sharply into margins that could be squeezed by price changes. On top of this, several new pipelines are in the works to increase the supply of Russian natural gas to its major markets and keep prices competitive. Finally, it is easier to export the


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