Skip to main content

Morning Update

Overnight volumes have been expected light ahead of the Christmas holiday. S&P 500 futures traded down to test Friday’s lows but have since bounced and are down small from Friday’s close. This move has closely tracked trading in the Yen and Euro, with the Yen and Dollar hitting highs as the S&p hit lows. Currency markets should be a good barometer of risk sentiment this week as equities see low volume. Look for the S&P 500 to follow the EUR/USD pair and the USD/JPY pair. When markets reopen on Wednesday morning expect the focus to be on the fiscal cliff again, with Obama’s “Plan B” in the spotlight. The bill Obama is expected to try and pass will likely extend tax cuts for people making less than $250K, increasing capital gains and dividend taxes to 20% and extending unemployment spending through 2013.

On Friday markets around the world tumbled as a bout of risk aversion, driven by Speaker Boehner’s failure to get enough votes to pass “Plan B”, swept markets. One stock that held up surprisingly well was General Dynamics, a defense giant. The S&P 500 ended 0.9% in the red but GD, after gapping down, ended up 0.2% and on its highs. In fact GD closed at its highest level in 6 months and is now decisively above where it was ahead of Obama’s re-election. The stock saw heavy stock and option volume on Friday, with the biggest trade of the day being the sale of 3400 Jan. 72.5 calls for $0.70 against 34,000 shares of stock bought at 70.10. This is a buy-write trade and shows that the trader is bullish on the stock with a price target of 72.5 at January expiration. This trade will profit if GD is above 69.40 at January expiration and can return a maximum of $3.10 if GD is at or above 72.50 at expiration.

A defense company like General Dynamics might seem like a strange stock to outperform the market on a day when fears of going of the fiscal cliff are high, but it is looking like the fiscal cliff will not be as bad as previously thought for the sector. On Friday the House and Senate passed a bill that will give the Pentagon $640.7 billion for the fiscal year that began on Oct. 1st for defense programs. This is $1.7 billion more than President Obama requested, which is why the defense sector has caught a bid. General Dynamics will benefit in particular because the deal includes a contract for a new Virginia class submarine from General Dynamics as well as a contract to continue production of upgraded Abrams tanks for the Army.

This defense bill had bi-partisan support and is likely to be signed by Obama. This provides the future of General Dynamics with some certainty and has given investors the confidence to step back into the stock. I recommend using a buy-write strategy like this trader did because it provides exposure to the stock while limiting the downside and cutting some of the day to day volatility. The market, and defense sector included, is not out of the woods yet and this holiday trading could cause significant gyrations in the market. That said, the January expiration cycle is typically a great time to be short option premium because of the holidays. By selling a call you get to keep the option premium collected no matter where GD is at expiration, and this premium can greatly enhance returns in a choppy market.

Comments

Popular posts from this blog

Is the KCJ Foreshadowing a 2008 Repeat?

The CBOE Correlation Index (KCJ) is close to the lowest level we have seen since it was first listed in 2007. The KCJ measures the implied movement of the S&P 500 components options, compared to the implied movement of the S&P 500 index options. Simply put, the higher the number, the more likely all stocks are going to move together. Conversely, a low number will be characterized by sector rotation, and flat markets; one sector moves higher, another moves lower.  (Source: Access Hollywood) Correlation, for lack of a better term, is correlated with volatility. Not surprisingly, 30-day S&P 500 historical volatility is near the low level of 6.5%. Currently at 33.5, KCJ is sitting close to rock bottom, lower than where it was in 2007, (but not lower than where Lindsay Lohan was in 2007).  So far this year, the market has been able to grind higher, characterized by leadership in FANG(Facebook Apple/Amazon, Netflix, Google) and sector rotation. A...

Unusual Options Activity

Yesterday 20,039 EEM September 41.5 calls were bought at the ask for $0.37 and 51,558 EEM Nov. 36 puts were bought at the ask for $0.35. VXEEM, the CBOE Emerging Markets ETF Volatility Index traded down near its 52-week low, and this trade was a bet that volatility is bottoming out and will increase. EEM closed yesterday at 41.68, so the call strike is much closer to the money than the puts. This suggests the trader is also bullish on emerging markets but is protecting himself should there be a strong reversal and a break of support in the 37 area. Yesterday we also saw a lot of call buying in the financial sector as traders made bets banks would rally into November expiration due to Fed easing. On trader bought 38,671 BAC November 10 calls for $0.26. Bank of America’s 52-week high is 10.10, and this trade is a bet that the bank trades higher than that in the coming months. We also saw a trader sell 44,211 XLF Oct. 17 calls and buy 40,000 XLF Nov. 17 calls for a net debit of $0.09. Th...