Risk off, Really?

Cusick’s Corner

I had a great piece of feedback last night from a reader who said that the “Risk is never off.” His comment was in reference to a subject line that we had, “Risk off Still Holding”. He is right, “Risk” is never off, but it can be mediated and the only way that I can see how to do that is through the use of options/derivatives. Whether it’s a covered call to generate income or a protective put insuring a holding or pairs trade (i.e. long Tech/Short Bonds), and not just a balanced portfolio of 60% Equities/40% Bonds, because this is a dynamic marketplace, Price and Volatility are all in motion and it’s difficult to have that right balance without active management. The reality is you need to determine your risk tolerance and then choose the vehicles that fit that tolerance. Most of us have in the past been resigned to pay a manager to do just this but with the rise of these products — derivatives, ETFs, Powerful Platforms, Education etc. — you are now empowered to manage and execute the plan that you have developed. David thanks for the feedback.

Stocks closed mixed on a slow news day. With no economic data to guide morning action, the underlying tone of trading was cautious after Standard & Poor’s warned yesterday that it might cut the sovereign credit ratings of 17 EU nations. Stock market averages pared gains Monday afternoon when the news was announced. However, trading across the Eurozone was orderly today and action on Wall Street is relatively uneventful as well. The Dow Jones Industrial Average has managed a 40-point gain at midday. However, the tech-heavy NASDAQ lost 12 points. CBOE Volatility Index (.VIX) edged down .10 points to 27.74. Overall options volume is light today, with 3.5 million calls and 2.6 million puts traded through 12:15pm ET.

Bullish Flow

An interesting spread trades on the CBOE Volatility Index (.VIX) today. The index, which tracks the expected volatility priced into S&P 500 Index options, hasn’t been doing much. VIX has traded in a narrow .63-point range and is down .10 to 27.74. One strategist seems to be expecting a spike over the next two months, however, and initiated a massive December 35 – February 55 call spread on the index. In this play, the strategist sold 55,000 VIX December 35 calls at 80 cents and bought 55,000 February 55 calls at 65 cents. The spread, for a net credit of 15 cents, might be a bet that VIX will hold below 35 through the December expiration (in two weeks) and then rally beyond 55 through mid-Feb. The spread might also roll a bullish position from December to February. Also note that VIX options are based on forward values and do not necessarily reflect the current values of the cash index.

Some players seem to be betting on International Game Technology (IGT) Tuesday. Shares of the Las Vegas, NV maker of electronic gaming equipment are off 11 cents to $17.39 through midday. Meanwhile, options volume on the stock is running 3X the daily average. 3,940 calls and 460 puts traded on the stock so far. The action is focused on December 18 calls, which are now 3.5 percent out-of-the-money and expiring in 10 days. 3,130 traded against 580 in open interest. In addition, with 91 percent of the volume trading at the asking price, it appears that call buyers are taking positions and looking for the stock to rally beyond $18 through the Dec expiration. No news to explain the heightened activity in IGT today.

Bearish Flow
Two of the top options trades so far today are in the SPDR 500 Trust (SPY), which is flat at $126.22 per share. In this spread, the strategist apparently bought 20,000 December Quarterly 125 puts on the ETF for $2.96 and sold 20,000 December Quarterly 120 puts at $1.46. Therefore, they paid $1.50 for the spread. It has traded more than once today and volume in both contracts now exceeds 45,000. Quarterly options are contracts that expire at the end of each quarter. In the case of December QTRLYs, the contract expires at the end of the calendar year as well. An institutional investor might be buying the 120 – 125 put spread to hedge recent market gains through the rest of 2011. The spread offers its best payoff if SPY falls to $120 or less before 2012, which represents a market decline of almost 5 percent.

Arch Coal (ACI) loses 9 cents to $16.36 and options volume on the coal producer through midday is 7,025 puts and 1,190 calls. December 17 puts, which are now 64 cents in-the-money, are the most actives. 4,210 traded and, with about 60 percent of the volume trading at the ask, it appears that put buyers are driving the action. Open interest is 753 and so this appears to be fresh positioning in ACI puts. December 16s on the stock are seeing interest as well. 1,423 contracts changed hands. No news on the stock to explain the high put volume and the bearish trading comes after a rough stretch for shareholders. ACI is down 54.8 percent since March.

Unusual Volume
Success Factors (SFSF) options volume is running 7.5X the (22-day) average, with 40,000 contracts traded and call activity accounting for 99 percent of the volume.

Eli Lilly (LLY) options volume is 5.5X the average daily, with 40,000 contracts traded and call volume representing 56 percent of the activity.

Hecla Mining (HL) options volume is running 6X the average daily, with 72,000 contracts traded and call volume representing 95 percent of the total volume.

Increasing options activity is also being seen in Nabors Industries (NBR), Baxter International (BAX), and Darden Restaurants (DRI).

Implied Volatility Mover
Implied volatility in Toll Brothers (TOL) options is easing today after the homebuilder reported earnings. The company said it earned 9 cents per share in the fourth quarter, which was three cents better-than-expected. Revenues also beat estimates. Shares, which had rallied 48.1 percent in the two months leading up to the report, slipped on the news, but are now up 21 cents to $20.95. Options on the stock are seeing brisk trading. 4,825 calls and 2,485 puts traded in TOL. Dec 22 calls, which were being bought ahead of the report (see yesterday’s closing wrap), are the most actives. Some players might be liquidating positions on the news. 4,000 traded (97 percent Bid) and implied volatility in TOL options is down 14.5 percent to 39.


Joe Cusick

Cusick’s Corner