Weekend Review

Barrons –

Steven Sears is back at the helm and he writes about a pretty basic strategy – buying a call. Long options often have the difficulty of overcoming time value when implied volatility is low. If you are not aware, implied volatility is low with VIX under 14.00. The result is historically inexpensive option contracts. The column discusses buying calls on the Financial Select Sector SPDR (XLF – 15.13). XLF is mostly made up of large financial stocks which should continue an upward climb if the overall stock market continues to move higher. A specific situation that was noted was a large buyer of September and October XLF Call options. It appears 150,000 XLF Sep and Oct 16 strike calls were purchased last week. This would definitely represent a bullish outlook on financial stocks.

Options Action –

Options Action is back now that the Olympics are over. The guys return talking about the overall bullishness in the overall market nothing that this is a narrow based rally. Even with the market making new highs, the number of stocks making new highs is dropping. This sort of divergence often occurs before a stock market top. Finally, the low VIX was cited as an indication of investor complacency. Complacency is often the quiet before a storm in the markets.

The first recommendation is on YUM! Brands (YUM – 66.10). YUM gets a lot of growth from the Chinese market and the stock market over there is on three year lows. Take this as an indication that business may not be so hot in China. YUM on the other hand is up about 11% on the year. The feeling is this disconnect will result in lower prices for YUM stock in the near future. A bear spread is the trade here. In order to capture the next earnings release October options are used in the spread. The spread buys a YUM Oct 62.50 Put at 1.40 and sells a YUM Oct 55.00 Put at 0.30 for a net cost of 1.10. The best result here is YUM at 55.00 or lower in October and a profit of 6.40. The maximum loss occurs if the stock is over 62.50 and is equal to the price paid for the spread or 1.10.

The next trade was on Tiffany & Co (TIF – 60.66) which is a stock that has broken a long term uptrend. A stock breaking an uptrend leads to a bearish outlook for shares and that is the trade recommendation here. This trade is an exotic one and looks out to November. The trade buys 1 TIF Nov 60.00 Put at 3.40 and then sells 2 TIF Nov 52.50 Puts at 1.10 each for a net cost of 1.20. If TIF is at 52.50 at expiration this would be the best of outcomes and result in a profit of 6.30. As the stock continues to drop in price the profits end up being lower and below 46.20 this trade would overshoot the downside and actually turn into a loss. The payout diagram below illustrates how this trade works out at expiration.

For more information on VIX trading this past week check these blog entries as well –

http://www.cboeoptionshub.com/2012/08/18/this-week-in-vix-and-vxn-by-russell-rhoads-cfa-2012-08-18-6-34/

and

http://www.cboeoptionshub.com/2012/08/17/this-week-in-vix-options-and-etps-by-russell-rhoads-cfa-2012-08-17-6-02/

TIF Payout.jpg