Hot Option Plays: Could This Close Be Healthy?

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Cusick’s Corner 02-15-2012
I have been talking more and more about correlated assets and how some highly correlated assets are starting to diverge. I have been watching the Japanese markets running to the upside and I looked at the bond yields, specifically the 10 yr, and they have been moving together until now. If the Japanese markets continue to run and the correlation is still valid, 10 yr yields should be bouncing and that would be a potential catalyst for the bulls. With Tech, QQQ, breaking late in the day, the S&Ps and RUT followed under the pressure. See you Midday.

Stock market averages slumped on mixed economic news and amid ongoing concerns about the Eurozone Wednesday. Trading was orderly early after the NY Empire State Index of manufacturing activity showed an increase to 19.5 in February, from 13.5 last month and significantly better than the 14.0 that was expected. News that China was set to offer additional financial assistance to the Eurozone also helped sentiment in morning trading. However, the day’s other news was mixed. Industrial production was flat in January. A .6 percent increase was expected. A third piece of data showed the NAHB Index of Homebuilder Sentiment jumping to 29 in February, from 25 the month before and significantly better than the 26 that was expected. Investors seemed unimpressed with the data. While the NASDAQ was sporting a modest gain in late-morning trading, the Dow was showing a modest loss. Then selling pressure was notable shortly after 1:00 pm ET. The catalyst for the midday weakness was not obvious, as there didn’t seem to be any major news items on the wires. Apple Computer (NASDAQ:AAPL) saw very volatile action. The stock, which hit a record high of $526.29 early, tumbled to a low of $496.89 on heavy volume. The decline weighed on the NASDAQ. Meanwhile, Fed minutes from the latest rate policy meeting offered little new information. Fed officials were divided on whether or not another round of bond buybacks will be needed. Stock market averages were already under pressure before the minutes made the rounds and failed to bounce into the close. At the end of the day, The Dow had lost 97 points. The NASDAQ erased morning gains and finished down 16 points.

Bullish
Kellogg (NYSE:K) saw relative strength and high call volume today after the company ironed out a deal to buy the Pringles brand from Procter and Gamble. Kellogg shares added $2.57 to $52.87 and options volume jumped to 8X the daily average. 19,000 calls and 4,500 puts traded on the stock. February 52.5 calls, which are now 37 cents in-the-money and expiring at the end of the week, were the most actives. 8,520 contracts changed hands. Investors also snacked upon Kellogg March 52.5, March 55 and June 55 calls. Some players were probably buying short-term at-the-money and out-of-the-money calls on hopes for additional gains in the underlying in the weeks ahead. Prior to today, shares had been chopping around in a range for several months, but did add 2.6 percent on Feb 2 after earnings were reported. K is now up 6.9 percent month-to-date and at its best levels since November 2.

Bullish trading was also seen in Decker Outdoor Products (NASDAQ:DECK), Liz Claiborne (NYSE:LIZ), and Cablevision Systems (NYSE:CVC).

Bearish
Corinthian Colleges (NASDAQ:COCO) added a dime to $4.88 and has staged an impressive 61 percent surge so far in February. Noteworthy options trades on the for-profit education company today included a massive strangle. In this strategy, the investor sold 24,000 August 4 puts on COCO at an average of 28.5 cents and sold 24,000 August 6 calls at 29 cents. In other words, the strategist wrote an Aug 4 – 6 strangle at an average 57.5 cents per strangle. The trade will create the largest blocks of open interest in COCO. The strangle write is not necessarily a bullish or bearish play, but a view that the underlying stock will stay between the two strike prices through the expiration. The maximum potential gain from the position is the credit received for selling the premium. There are risks from a move higher or lower in the underlying, because the options are sold “naked” and not covered by another position.

Bearish trading was also seen in Earthlink (NASDAQ:ELNK), Chimera Investments (NYSE:CIM), and Quest Diagnostics (NYSE:DGX).

Index Trading
CBOE Volatility Index (.VIX) saw a sizeable move Wednesday. The market’s so-called “fear gauge” hit a high of 21.77 and finished up 1.60 to 21.14 amid ongoing worry about the European debt crisis. Greece is inching along in negotiations with creditors, but no decisive deal has been reached ahead of a March deadline to avoid a debt default. The uncertainty seems to be keeping a bid under the volatility index. Meanwhile, VIX February options expired today and the settlement was 20.44. Upside 30, 35 and 55 calls had the largest open interest positions in the index ahead of the expiration. All three contracts expired worthless. March 24, 29 and 35 calls were the most actives in the index today, as some investors were probably opening new positions in March after February call options had expired. The flow included a hefty premium purchase, in which the investor bought 20,000 March 29 calls and 20,000 March 35 calls on the volatility index, possibly opening a new position to hedge risk of higher volatility in the weeks ahead.

ETF Action
A hefty spread traded in the iShares Small Cap Fund (IWM) Wednesday. Shares lost 34 cents to $81.61 and a March 74 – 80 put spread was bought on ETF for $1.25, 40000X. In this play, the strategist bought 40,000 March 80 puts for $1.89 and sold 40,000 March 74 puts at 64 cents. The spread was possibly initiated to hedge the risk of a downturn in the Russell Small Cap 2000 names in the weeks ahead. IWM has rallied more than 22.4 percent since late-November. The Mar 74- 80 put spread will offer its best pay off if shares fall to $74 or less through March, which represents a 9.3 percent decline, or a 50.5 percent retracement of the recent advance, over the next 30 days.

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