Canary Still Chirping

Cusick’s Corner 07-23-2012 5:10 PM

Today was a day best spent managing your shorts if you had them on and not chasing the markets after the open we saw today. The market needs to reestablish support above 1350 on the S&Ps if the bid is going to gain any further conviction. This action has to be a little disconcerting to the Bears because that open this morning was as ugly as it gets and there was not the conviction selling one would think there would be — volume was light. The two things that I do not like is that Finance, XLF, continues to break and the Small Caps, IWM, are seeing lower highs and lower lows in the higher beta index which is not a good sign. The Euro Currency, FXE, was able to hold $1.20 and bounced into the close, so the canary continues to chirp.

Stock market averages fell in volatile action, but finished well off session lows Monday. Weakness overseas set the table for morning losses on Wall Street after Hong Kong’s Hang Seng shed 3 percent on concerns about recent slowing in China — the world’s second largest economy. Anxieties about the Eurozone debt crisis also weighed on sentiment after yields on Spanish debt continued setting new highs. Worry that Greece isn’t doing enough to secure bailout funds was another catalyst for volatility in European equity markets Monday. Germany’s DAX helped pace the decline with a 3.2 percent drop. The euro slipped to two-year lows of 1.2135 against the buck and crude oil prices plummeted $3.69 to $88.14. Meanwhile, the economic calendar is light until Wednesday and so earnings will drive a lot of trading this week. McDonald’s (MCD) lost 2.9 percent today and was the biggest loser among twenty-four Dow stocks trading lower. Shares slipped after the fast food giant posted earnings that fell short of Street estimates. At the end of the day, the Dow Jones Industrial Average is down 102 points, but 137 points off session lows. The NASDAQ dropped 35.

Bullish
Options action was heating up in Arch Coal (ACI) Monday. Shares hit a morning low of $5.90, but erased early losses to finish up 16 cents to $6.32. Meanwhile, about 14,000 calls and 2,725 puts traded on the coal producer. August 7 calls, which are 10.8 percent out-of-the-money and expiring in 25 days, were the most actives. 6,445 traded. August 8 calls were the second most actives. 4,425 changed hands. ACI has plummeted nearly 78 percent during the past twelve months. Short interest has increased to 43 million shares or 26.5 percent of float (as of 6/29). Some short sellers might be hedging their positions with upside calls on ACI, in case earnings results spark a fire in Arch Coal when the company reports on July 27.

Bullish trading was also seen in Alpha Natural Resources (ANR), Gap Stores (GPS), and MBIA (MBI).

Bearish
Under Armor (UA) will be a name worth watching tomorrow. The athletic apparel maker reports earnings before the opening bell. Shares stumbled like Tiger Woods on hole number 6 and lost $1.21 to $48.38 Monday. Meanwhile, options volume rose to 7X the daily average ahead of the earnings news. The order flow included a substantial three-way spread on UA, in which the investor apparently sold 6,000 August 55 calls on the stock at 85 cents, bought 6,000 August 47.5 puts for $3.20, and sold 6,000 August 42.5 puts at $1.40. In other words, Aug 55 calls were sold to buy Aug 42.5 – 47.5 put spreads for 95 cent debit (on the 3-way package), 6000X. It’s the type of bearish play that an investor typically initiates if they are concerned about a possible slide in the share price and want to make profits from the move. An investor with a position in UA might have initiated the trade to hedge the earnings risk.

Bearish trading was also seen in LexMark (LXK), Cheesecake Factory (CAKE), and Talbots (TLB).

Index Trading
CBOE Volatility Index (.VIX) saw a dramatic run to 20.49 this morning, a 26.8 percent spike from Friday’s closing levels, as a wave of contagion rippled across Asia, throughout Europe, and then hit US shores. However, the market sell-off was orderly and, in fact, the Dow had trimmed its losses to double digits in afternoon action. Still, the Dow fell 102 points Monday and suffered its first triple digit loss since April. VIX finished the day up 2.35 points to 18.62 and trading in the options on the volatility index was relatively active, but really lop-sided. 259,000 calls and 69,000 puts traded on the index. August 30, 20, 40, 25, 24, 23, 28 and 32.5 calls were the eight most active contracts on the index, as it seems clear that some investors are taking positions in August upside calls on the index on worries about another spike in market volatility before the August expiration.

ETF Action
An impressive spread trades in the SPDR 500 Trust (SPY) Monday afternoon. SPY, which is the exchange-traded fund that attempts to mirror the performance of the S&P 500 Index (.SPX), lost $1.38 to $135.09. In afternoon trading, a hefty block of 84,000 August 128 puts traded on the ETF for 62 cents. It coincided with a block of 42,000 August 133 puts for $1.53 and 42,000 August 123 puts for 25 cents. It’s all part of a massive butterfly spread, which is an advanced strategy that, in this case, would be similar to buying an Aug 128 – 133 put spread on SPY and selling a 128 – 123 put spread. A total net debit of 54 cents is paid for the spread (plus transaction costs) and the best payoff happens if shares fall to the middle strike (sweet spot) of the butterfly through the expiration, which in this case represents a 5.2 percent market decline over the next 25 days.

Joe Cusick
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