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Morning Update

Yesterday the S&P 500 was only down 0.5% but the VIX was higher by over 18%, showing that traders were exceptionally skittish after getting surprising news from Cyprus. A higher VIX means that there was increased demand for options. In most names the option trading was dominated by purchasers of out of the money puts to limit downside risk to long stock positions. But in Conoco Phillips we saw traders come in and buy large quantities of out of the money weekly calls to play a pop in the stock with minimal risk. The biggest trade of the day was the purchase of 9249 Weekly 60 calls for $0.21 with the stock at 59.35. This trade will profit if COP is above 60.21, 1.5% higher, by the close this Friday.

Yesterday COP opened down 0.70% and immediately began trading higher. The weekly 60 calls opened at $0.08 and traded as high as $0.31 during the day. This highlights the benefit of weeklies, which is leverage. Because expiration is just days away the options are extremely sensitive to changes in the underlying price of the stock and can be used to gain exposure to a company without putting a lot of risk, or margin on the table. This trade is a momentum play that is betting that yesterday’s sell off was overdone. The dip was immediately bought at the open yesterday, which confirms that there is money on the sidelines waiting for a buying opportunity.  These calls are likely to remain active most of the week and will likely be sold for a profit into strength in the market. While weekly options offer an excellent risk/reward ratio they also suffer from rapid time decay if they do not move in the money, meaning that there is substantially risk that they expire worthless. Therefore they are best used for quick momentum plays on stocks and not necessarily held to expiration.

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